A Guide to Home Equity Loans and Lines of Credit

A Guide to Home Equity Loans and Lines of Credit

What is your home's "equity"? The difference between what your house is worth, and what you owe on the home, is defined as your available equity.

A home equity loan or line of credit (HELOC) is secured by the available equity in your home.

In some cases, you may be able to borrow up to 125%. However, be careful when borrowing more than 80%. If house values in your area fall, so will your home equity and borrowing limit. Your lender may "call" your loan, asking you to pay back any borrowed funds in excess of the new, lower limit.

You can use the home equity worksheet at the end of this guide to determine your available equity.

Typical uses for a Home Equity are:

• Debt consolidation
• Home improvements and landscaping projects
• New cars purchase
• Tuition fees
• Emergency auto repairs, emergency purchases - such as appliance replacement, furnaces, etc.

Renovations and home improvements/repairs are an especially appropriate purpose for a home equity loan or line of credit, because you are putting money back into your home, thereby possibly increasing its value.

Consolidating debts that carry a high interest rate, such as outstanding credit card balances you currently struggle with, is also a good purpose for a home equity loan or line, as long as you resist the urge to charge up more debt. A long-term, fixed-rate home equity loan allows you to pay off all your cards, leaving you with one predictable, lower monthly payment.

But Why Not Just Refinance?

To determine if you should refinance your home and pull additional cash out for expenses, you should look at the terms and conditions of your first mortgage.

Is your current interest rate low? - If the interest rate on your first mortgage is low, and in line with current market rates, you probably don't want to refinance in order to pull cash out.

Unless:

• Have you owned your home for several years? Typically, interest rates for a 15-year fixed rate mortgage are lower than that of a 30-year mortgage. If you have owned your home for many years, you might wish to look into current rates on lower-term mortgages. GetSmart has calculators available to help you determine your savings under various scenarios.
• When considering your options, keep in mind you'll need to factor in any pre-payment penalties your current first mortgage lender might charge.
• Remember, refinancing generally involves higher closing costs, and if you refinance and pull cash out to pay off other debts, you are financing those debts for the period of your new loan.

A Loan or a Line?

Depending on the purpose of the loan, you can choose either a home equity loan, or a home equity line of credit.

A home equity loan is a lump-sum of money you receive. The loan generally has a fixed interest rate, which is usually slightly higher than a first-mortgage interest rate. You start making payments on the loan as soon as you receive it, and once you pay it off, it's gone.

A home equity line of credit is an amount of money that is made available to you - similar to the available balance on a credit card. The line generally has a variable interest rate, with a pre-agreed ceiling, or "cap". You only access as much as you need, and make payments only on that amount. You can use the funds, pay them down, and then use them again. The funds are generally available to you for a certain term. At the end of that term, if there is anything outstanding, you can either pay it off or roll it into a loan.

You should probably choose a Home Equity Loan if:

• You know exactly how much money you need.
• The funds are for a specific purpose.

Alternatively, a home equity line of credit might be the better choice:

• If you aren't certain how much money you will need - say, for a large home improvement project.
• Or, if you know you will pay the balance down in five years or less - say, for a new car purchase.
• Or, if you know you will need access to funds periodically over the course of several years - say, for tuition

There are many different home equity loan and lines of credit products available, with different terms and conditions, so be sure to speak with your lender regarding the specifics of their offers.

When you use the equity in your home to secure a loan or line of credit, be careful. You might wish to think twice before you use your home's equity to purchase stock or invest in a new business venture, for example. If the stock value falls, or the business loses money, your home could be at risk

Remember, since the loan is secured by your home, the lender may foreclose if you don't repay the money. To be safe, always avoid borrowing more than you can afford.

There are many different home equity loan and lines of credit products available, with different terms and conditions, so be sure to speak with your lender regarding the specifics of their offers.

When you use the equity in your home to secure a loan or line of credit, be careful. You might wish to think twice before you use your home's equity to purchase stock or invest in a new business venture, for example. If the stock value falls, or the business loses money, your home could be at risk

Remember, since the loan is secured by your home, the lender may foreclose if you don't repay the money. To be safe, always avoid borrowing more than you can afford.

Glossary:

Cap - Consumer safeguards which limit the amount the interest rate on an adjustable rate mortgage may change per year and/or the life of the loan.

Closing Costs - Includes a loan origination fee, points, appraisal fee, title search and insurance, survey, taxes, deed recording fee, credit report charge and other costs assessed at settlement. The closing costs usually are about 2 percent to 6 percent of the mortgage amount.

Fair Market Value (FMV) - Potential sale price for a piece of property if it were sold on the open market.

Fixed Interest Rate Mortgage - A mortgage on which the interest rate is set for the term of the loan.

Pre-payment Penalty - Money charged for an early repayment of debt. Prepayment premiums are allowed in some form (but not necessarily imposed) in 36 states and the District of Columbia.

Term - The period of time between the beginning loan date on the legal documents and the date the entire balance of the loan is due.

Variable Interest Rate - The interest rate is adjusted periodically based on current market conditions.