Home Equity Loans and HELOCs – Getting a Good Deal
At some point, you’ll probably
need money that you don’t have handy, possibly for a home improvement project
or a large, unexpected expense. What do you do if you don’t have the money in
your checking account? If you own your home, you have the option of getting a
home equity loan or a home equity line of credit.
A home equity loan is basically a
second loan (after your mortgage) that you take out on your house. But where
the first loan (your mortgage) goes toward the purchase of your home, the
second loan (the home equity loan) is a lump of cash the bank gives you to
spend as you please.
Once you’re approved for a home
equity loan, you receive a check for the total loan amount. Home equity loans
have a fixed interest rate and a fixed term (the amount of time you have to
repay the loan), usually 10 to 15 years. You make monthly payments on the loan
until it’s all paid up.
With a home equity line of credit
(HELOC), you’re approved for a total loan amount, but bank does not give you
money in a lump sum. Instead, you get a credit/debit card, or a checkbook (or
both) and you withdraw money when needed. You only pay interest on the amount
you’ve taken out, and you’re only limited by the total amount of the loan. Up
to $100,000 of the loan is tax deductible.
HELOCs are trickier than typical
home loans that pay you one lump sum up front. Here are some characteristics of
these credit lines:
• Fluctuating Interest Rates – A line of credit with fluctuating rates can make
your payments increase, sometimes drastically. Some lenders offer a low
“introductory rate,” only to increase it after a month or two.
• Advance Period Terms – HELOCs with these terms allow you to access the money
for a set period of time, say five years. Once that term is up, you can’t
withdraw money and you must to repay whatever you borrowed in the next ten
years (known as the “repayment period” ).
• Balloon Payment Terms – Some HELOCs only charge you interest for ten years,
but then may charge you an additional fee that is due at the end of the loan’s
terms. Sometimes this balloon amount tagged on at the end so large, that
borrowers refinance to include the balloon amount.
Should You
Use Home Equity?
Should you look for a traditional home-equity loan (that pays you right away)
or a home-equity line of credit, which that extends a line of credit over time?
Well, if you have a single,
discrete expense (like a kitchen remodel), a regular home-equity loan is the
right move. You get your money, you pay for the project and you start repaying
the loan right away—in monthly payments that remain the same over the life of
the loan.
But if you’re looking at a series
of payments over a period of time, or want a safety net that you can bail you
out at a moment’s notice, a HELOC is the better choice—you’ll only pay for the
money you need.
Most home-equity loans and HELOCs
use the following formula to determine how much to lend: 75-80% of current
home’s value (determined by an appraiser’s visit, which you pay for) minus the
amount you owe on your mortgage. When real estate values decline, getting a
HELOC gets tougher, but it’s still an option for many homeowners.
Here’s an example that assumes
the bank will lend 75% of your home’s value:
Current home value: $400,000
75% of current value: $300,000
Size of your mortgage: $250,000
Amount lent to you: $50,000
Some lenders will lend you even
more than 80% of the value of your home – up to 100% or even 125% of the home’s
appraised value. But a home equity loan that large is risky, since your home
might not appreciate that much by the time you’re ready to sell. Indeed, home
values haven’t risen much at all of late. If your home declines in value or
rises very little, you could get stuck owing money on your home equity loan, even
after you sell the house. Here’s how such a huge home equity loan can become a
huge headache:
Current home value in 2008:
$400,000
125% of home value: $500,000
Size of your mortgage: $250,000
Amount lent to you: $250,000
Sale price of your home in 2011: $475,000
Mortgage in 2011: $240,000
Total amount owed (mortgage and home loan): $490,000
In this example, you still owe
the bank $15,000 more than the home’s sale price. And that’s not even including
the closing fees, moving expenses, and other costs associated with selling.
Right now, you read about a lot of people who’ve gotten into trouble because
they took out more money than their houses were worth, and are unable to pay
off the debt.
Where and How to Get a Good Deal
Now that we’ve scared you enough with the risks involved in using home equity,
we should tell you that there are some benefits.
A benefit of a home equity loans
and HELOCs is that your credit score and credit history don’t really have any
effect on your loan’s approval, or on the rates that you pay. That’s because
your home is the collateral. This may be good if your credit score isn’t so
hot, but keep in mind that, if you don’t make payments, the lender can
repossess your home. Also, just like a mortgage, up to $100,000 of the interest
you pay on a home equity loan is tax deductible. In terms of your credit score,
a HELOC is treated as a line of credit, so adding the new account will result
in a temporary ding on a score, but if used responsibly, HELOCs add to your
credit history, thus raising your score.
The approval process for a home
equity loan or HELOC isn’t as strenuous as the mortgage approval process.
Generally, all that’s required to apply is an appraisal of your home and
verification of your income. This also means that approval comes more quickly.
Usually, you can get a home equity loan or HELOC in a matter of weeks– it’s
much quicker than the months-long ordeal of securing a mortgage.
But make sure you understand the
fees involved, which are less than the fees you pay on a mortgage, but
significant nonetheless. This makes sense, since the loan you’re taking out is
smaller. When it comes to fees and interest rates on these loans, you may want
to shop around. Don’t feel obligated to get your home equity loan or line of
credit from the same lender that handles your mortgage – the two aren’t
connected in any way. But do check with your mortgage lender – they may be more
likely to cut you a deal, since you’re already a customer.
Also, read all the fine print on
a HELOC. Some lenders require you to withdraw money—whether you want to or
not—several times a year; they may also exact a heavy penalty (up to thousands
of dollars) if you decide you don’t want the loan anymore, pay it back entirely
and close the line of credit (this is called a “prepayment penalty”). Not all
loans have these conditions, so if you’re thinking of getting a HELOC but have
no real intention to use it, make sure you can leave it alone without it
costing you anything extra.
One last tip: go to a credit
union. Credit unions often offer better home equity rates than other banks and
lenders. If the credit union doesn’t work for you, shop around your local banks
as well as online.
What is a
home equity line of credit?
A home equity line of
credit, also known as a HELOC, is secured by your home and allows you to
access the available equity Information Panel
you have in your home. With a HELOC, you can borrow as much or as little as you
need, whenever you need it, up to a credit limit established at closing. As you
repay your outstanding balance, the amount of available credit is replenished,
which means you can borrow against it again, if needed, throughout your draw period. Information
Panel
Popular HELOC uses include making
home improvements that might increase the value of your home and consolidating
higher-interest rate debt on other loans (such as credit cards and auto loans).Footnote
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