Differences Between a Home Equity Line and Loan

There are basically two types of home equity loans: a home equity loan (HEL) or a home equity line of credit (HELOC).

There are basically two types of home equity loans: a home equity loan (HEL) or a home equity line of credit (HELOC). Since the debt is secured by your home, the interest rate is typically less than that of a credit card or personal loan. Also, the interest paid on the loan may be tax deductible. (Always check with your tax or financial advisor before making any tax-related decisions).

Home Equity Loan (HEL)

A home equity loan, also referred to as a second mortgage, is best used in situations where you intend to use the funds for a specific purpose, like home improvements or a car purchase. The interest rate and the monthly payments are fixed. These get paid back in installments over a fixed period of time, typically 5-15 years. While the time to repay a loan is shorter than that of a traditional mortgage, borrowers like the certainty of having a fixed rate and fixed monthly payments.

Home Equity Line of Credit (HELOC)

A home equity line of credit is a revolving line of credit that allows you to access the funds as you need, instead of all at once. The interest rate is variable and in most cases tied to prime. The rate for which you qualify is usually based on your creditworthiness and your ability to repay the loan.

Advantages and disadvantages of using each type of loan

Knowing when to use which type of loan depends on your specific circumstances. If you have a long term remodeling project which requires cash installments over time, then a line of credit makes sense. If your home needs a major upgrade and you are making one large payment, then the stability of a home equity loan may be a better choice.

 

Advantages of HELs and HELOC
HEL (Home Equity Loan) HELOC (Home Equity Line of Credit
Fixed interest rate. Although you pay interest on the entire borrowed amount, your rate is locked in if rates swing upward. Variable interest rate. You pay interest on the amount you access from your line of credit, rather than the entire loan amount.
Attractive interest rates (lower than credit cards or personal loans). Attractive interest rates (lower than credit cards or personal loans).
Loan interest may be tax-deductible. Loan interest may be tax-deductible.
There is one lump sum of money borrowed. Access to money as you need it.
Set monthly payments make it easier to estimate your expenses. As you borrow more, the minimum repayment will increase. However, interest-only repayment options are available.
Can link into a relationship banking product to receive rate discounts, free services, or added benefits. Can link into a relationship banking product to receive rate discounts, free services, or added benefits.

 

Disadvantages of HELs and HELOCs
HEL (Home Equity Loan) HELOC (Home Equity Line of Credit
Required to borrow the entire amount upfront whether used or not. Knowing money is available at any time can be tempting.
Fixed payments can take up to 15 years to repay Variable interest rate could adjust upward.
There are usually fees that add costs to the loan amount. There are usually fees that add costs to the loan amount.
Repayment of interest and principal begins as soon as you receive the money. Interest-only repayment options are available from most lenders.
If you cannot repay or refinance the loan, then you may be forced to sell or lose your home. If you cannot repay or refinance the loan, then you may be forced to sell or lose your home.

While the advantages for both types of loans may sound appealing, carefully evaluate whether the benefits each has to offer is worth incurring the additional debt. Compare home equity rates.

Six Helpful Tips for Home Equity Borrowers

As a homeowner, you have probably received offers in the mail to apply for a home equity line of credit (HELOC) or a home equity loan (HEL). If handled properly, these types of loans can provide you with additional funds. To assure that you are getting the best deal, here are some tips you will want to consider before selecting the right loan program.

As a homeowner, you have probably received offers in the mail to apply for a home equity line of credit (HELOC) or a home equity loan (HEL). If handled properly, these types of loans can provide you with additional funds. To assure that you are getting the best deal, here are some tips you will want to consider before selecting the right loan program.  Compare home equity rates.

  • Avoid unnecessary fees. The market for home equity loans can be very competitive. When shopping for the best offer be aware of any application fees,closing costs, or appraisal fees which can drive up your actual costs. Find a home equity loan that does not penalize you if you decide to pay off your loan early, or one that does not charge you a check writing fee each time you access your home equity line of credit.

 

 

  • Interest rate caps. Like a variable-rate mortgage, a HELOC is subject to change as interest rates fluctuate. This can work to your advantage should interest rates drop. However, be aware of how frequently your rate can adjust each year (e.g., quarterly is better than monthly.) Also look at the lifetime cap or maximum amount a rate can adjust each year.

 

 

  • Try to avoid pre-payment penalties. Everyone wants to have the flexibility of paying off their home equity loan early. The reward is not only being debt free but saving on interest charges. Work with a lender who is willing to waive any pre-payment penalties or who gives you the flexibility to make interest-only payments in case you encounter a financial hardship.

 

 

  • Ability to convert to a fixed rate. Since most HELOCs have variable ratesand can change at different times, what may seem like an attractive rate in the beginning may skyrocket later, should interest rates rise. Look for loan features that will allow you to convert to a fixed-rate loan should this happen.

 

 

  • Shop for the best rates. Shop and compare for the best HELOC rates online. Be aware of low teaser rates which will escalate after the brief introductory period. Make sure you know the index and margin used to calculate the fully indexed rate. Determine if the rates you are comparing are competitive once all fees have been calculated.

 

 

  • Bank on your relationships. Many financial institutions offer customers incentives, such as discounted interest rates, to maintain their banking relationship assuming certain requirements are met. Inquire with your current bank to see if they have such promotions available and check to see if you qualify.

How Can I Qualify for A Home Equity Loan?

Most financial institutions will let you borrow as much as 70%-80% of the loan-to-value (LTV) ratio of your home less any outstanding mortgage debt on your property.

Most financial institutions will let you borrow as much as 70%-80% of the loan-to-value (LTV) ratio of your home less any outstanding mortgage debt on your property. There are a variety of home equity loan products available, each with their own terms and conditions. The equity is collateral you can use when borrowing against your home and is calculated as follows:

How Much Credit is Available to You
Calculations Purchase
Appraised value of your home $300,000
Borrowing percentage* 80%
Percentage of appraised value $240,000
Less existing mortgage debt -$100,000
Potential credit line $140,000

* Actual percentages may vary depending on the lender and borrowed amount.

When determining your available credit line, the lender may take into consideration other factors including your past credit history, your current income, and your ability to repay a loan. After your credit history has been evaluated, a report will be generated which includes your credit score and lets lenders know which loan is best suited for you.

Maintaining a good FICO score

Your credit score is calculated by the Fair Isaac Corporation (FICO), which accesses the three main credit reporting bureaus (Equifax, TransUnion, and Experian). Credit scores can range from as low as 300 points to as high as 850. People with average credit usually score around 620, good credit at 660, and excellent credit above 720.

You can build and maintain a good credit score by always paying your bills on time, and by keeping a good utilization ratio. This means using less credit than is actually available to you. FICO scores are based on your rating in five general categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and types of credit used (10%) (Source: www.myfico.com). Whether you are new to using credit, or have been a long-time borrower, keeping these categories in mind and maintaining responsible borrowing habits can help you strengthen your credit score. Compare home equity rates.

Repayment Options for Your Home Equity Loan

Several factors can come into play when trying to select the right home equity loan. Each lender can set their own terms and rates and the repayment plan can also vary from lender to lender. Make sure you choose a loan with a repayment schedule that works for your situation.

Several factors can come into play when trying to select the right home equity loan. Each lender can set their own terms and rates and the repayment plan can also vary from lender to lender. Make sure you choose a loan with a repayment schedule that works for your situation. Compare home equity rates.

Repaying a Home Equity Loan (HEL)

If you decide to select a home equity loan, be prepared to receive a lump sum of money upfront from the lender. It is a lot like financing an auto loan where interest is charged on top of your monthly principal payments and amortized until your debt is repaid in full. The interest rate is fixed (generally up to 180 months or 15 years) and secured by collateral, in this case the equity in your home instead of your car.

Repaying a Home Equity Line of Credit (HELOC)

A home equity line of credit acts a lot like a credit card. Instead of fixed payments over a specified period of time, you are given a maximum credit line that you can borrow against in increments as needed and pay back in monthly installments. You can access your credit line as needed - for a specified period of time or draw period -- up to your credit limit either by check or by an access card linked to the HELOC.

You may pay interest only on the amount that is borrowed. However, at the end of the term you may have to pay the entire principal, usually in the form of a balloon; payment. Or you can pay a combined principal and interest payment each month. Most loans allow for principal and interest payments to be amortized over the repayment term.

Your monthly payments are based on the amount of interest you borrow and the current interest rate. The interest rate can vary since variable rate HELOCs are tied to a specific index and margin. Because the interest rate is tied directly to an index, it is advisable to look into how much your rate may change based on past history.

Five Things to Consider When Shopping for a Home Equity Loan

Before you rush to apply for a home equity loan, you will want to give serious consideration to how you intend to use the funds, since you are using your home as collateral.

Before you rush to apply for a home equity loan, you will want to give serious consideration to how you intend to use the funds, since you are using your home as collateral. To assist you in making the right decision, here are some potential risks you will want to be aware of:

  • Know your upfront costs. There may be costs for taking out a home equity loan. By comparing several lenders' rates and fees, you can make a better decision. Do not be afraid to question your lender about a fee you do not understand.
  • Getting a home loan is not temporary. While qualifying for the funds you need may be easy, taking on a long term payment could be detrimental to your financial goals. Replacing one debt with another may not be the best solution.
  • Beware of the balloon payment.Obtaining a low-interest rate home equity line of credit (HELOC) may require making a balloon payment at some point in time. Unless you decide to refinance, take out another loan, or sell your home before the payment is due, you may have to pay off the balance on your loan.
  • Be careful not to overspend. Since a home equity line of credit acts like an open line of credit you may be tempted to use your access card or write a check each time you need an infusion of cash. You might be better off saving these funds for large purchases. It is always best to have a goal and a repayment plan that works for you.
  • Beware of the maximum loan-to-value. Most financial institutions will let you borrow up to 80% of the loan-to-value (LTV) ratio of your home less any outstanding mortgage payments on your property. Some lenders may offer 85% or 90% LTV but those can come with higher rates. Always ask for their best offer. Be careful not to max out your equity, in case home values decrease.