Using Home Equity
With mortgage interest rates at all time lows, many homeowners have been thinking about the possibility of refinancing or taking out some of their home equity.
If you are thinking about using some home equity, there are a few things you should know. First of all, the most important thing to know is the difference between a home equity loan and a home equity line of credit.
A May 1, 2006 article posted on Bankrate.com, “Home equity loan vs. line of credit,” gives the basics on these two different types of loans so you will be able to make an educated decision should you decide to capitalize on your home equity.
“There are two types of home equity loans: term, or closed-end loans, and lines of credit. Both are sometimes referred to as second mortgages, because they're secured by your property, just like your original (first) mortgage. Home equity loans and lines of credit are usually for a shorter term than first mortgages. The most common type of mortgages runs 30 years, while equity loans typically have a life of five to 15 years.”
Now let’s look into the differences between the loan and the line. First off, the home equity loan is a lump sum that is paid off over a specified time with a fixed interest rate and the same payment paid every month until it is paid off.
A home equity line of credit, or HELOC, on the other hand is different than the loan in that it works more like a credit card.
“You are allowed to borrow up to a certain amount for the life of the loan -- a time limit set by the lender. During that time you can withdraw money as you need it. As you pay off the principal, your credit revolves and you can use it again. Let's say you have a $10,000 line of credit. You borrow $5,000, but then pay back $3,000 toward the principal. You now have $8,000 in available credit. This gives you more flexibility than a fixed-rate home equity loan.”
Now that you understand the differences between a loan and a HELOC, you may be wondering which option is best for you. Generally speaking, the answer is never in black and white, but there are some circumstances when one works better than the other.
A home equity loan often times works best if you need the money for a one-time fixed expense, such as a wedding or a roof replacement.
HELOCs on the other hand work best for money that is needed over a staggered period of time, such as to pay for a child’s schooling over the next few years.
The most common reason for taking out home equity is to pay off major debt, especially debt from a credit card.
“Consumers who have run up credit card debt will often borrow a lump sum and pay off their Visa, MasterCard and department store charges, then pay back the bank over time at a lower interest rate than the cards would have imposed. This sort of debt consolidation is the single most-popular reason people have for taking out home equity loans, and fixed-rate home equity loans are used slightly more often for this purpose lines of credit.”