Home Equity Mortgage

With a home equity loan, by comparison, your lender will give you a lump sum and you're typically charged a fixed intere st rate and repay the loan in fixed monthly installments. Home equity loans are best reserved for those times when you need a set amount of cash, for example, to complete a home improvement, start a business, or consolidate high-interest debt.

Line Of Credit

A home equity line of credit is a flexible way to borrow against the equity in your home. Once you open up a home equity line with your lender (in a process similar to, but less involved than, applying for a mortgage) you can borrow from it (up to a set amount) when you decide you need to, and you'll only pay interest on the money you borrow. As long as you don't borrow anything, you won't owe any interest.

Most home equity lines come with variable interest rates, though a few offer fixed rates. And these days, lenders offer many ways for you to conveniently tap your available credit, most often by writing checks or using credit cards linked to the line of credit.

Tax impact
 
Generally, the money you borrow against your home, either through a home equity loan or line of credit, is tax-deductible. The IRS lets you write off up to $100,000 in interest you pay on these loans (or up to $1 million if you use the money to fix up your home).
Their tax deductibility and their decent interest rates (as of early 2002, 5.2 percent on average for a $10,000 home equity line of credit; 4.6 percent for a larger, $30,000 credit line) make home equity lines of credit worth considering over many other types of personal loans (which are not deductible).

Using the money wisely
 
Just because you have easy access to a huge pot of credit doesn't mean you should tap it freely. Take care to use your line of credit responsibly; for example, to help cover your expenses if you exhaust your emergency fund during an extend ed layoff. Resist the urge to tap it for more frivolous reasons, like to pay for a trip to Europe or to buy the entertainment center you've always dreamed of.
 
Remember, any money you borrow is backed by your home. If you run up big expenses that you're unable to pay back on time, you put your house in jeopardy.And know this: Your stream of credit may not last forever. Many lenders check your credit annually. While your lender cannot accelerate the loan payments or change the terms, it can suspend or reduce your borrowing privileges.
 
Lastly, with so many lenders competing to offer home equity lines and loans these days, you need to be on your guard. The Federal Trade Commission warns consumers that there are a number of abusive tactics out there, including hiding loan terms and coercing homeowners to accept home equity loans they can't reasonably afford. For more on the warnings, visit the FTC's Web site.

What you should know about HELOC

Home equity lines of credit, also known as HELOC's, have become increasingly popular in recent years. You can simply use the equity in your home to qualify for a large amount of credit, which can be used when and how you wish. Interest rates on HELOC's are usually relatively low and there are certain tax benefits that are available to many homeowners. A home equity product is often a good lending choice for many borrowers. But, as with any loan, there are advantages and disadvantages. You should know exactly what you are borrowing and take the time to shop for the most favorable terms.

The main thing to keep in mind in regards to any loans against your home equity is that if you default on the loan, you could lose your home.

The Basics of HELOC

A home equity line of credit is a type of revolving credit. It is a secured loan, using your home as collateral. Many consumers have large investments in their homes which allow them to use the equity to fund major items, such as college educations, home improvements and medical bills. HELOC's are not recommended to fund day-to-day expenses.

When you are approved for a HELOC, you are approved for a set amount of credit. This is your credit limit - the maximum amount you can borrow at one time. Most lenders will set your credit limit by taking a percentage of the value of the home and subtracting the balance owed on the first mortgage.

For example, many lenders will only let you have a total of 75% of your home's value in mortgages. If your home is worth $100,000 and you owe $40,000, you will be able to take out a HELOC of $35,000.

Your income, credit history and other debts will also be considered in determining your credit line.

Most HELOC's have a fixed amount of time that the credit line will be open, usually from seven to ten years. When the time period is up, you may or may not be allowed to renew your credit line. If you aren't, you will no longer be able to borrow additional money. Many plans will ask for you to pay the loan in full at this time. Some only ask for a partial payment or will refinance you into a fixed equity loan.

Borrowers are usually given a credit card or checkbook to make purchases using the line of credit. Many require that you borrow a minimum amount each time you make a purchase. For example, you may not be able to write a check for less than $300 at a time. Many lenders require that you keep a minimum amount outstanding or that you take an advance when you set up the HELOC.

Shopping for a HELOC

When thinking about applying for a HELOC, there are many factors you should consider. There are many different plans out there, so it is important to take the time to shop for the plan that best fits your financial needs.

It is vital that you read the credit agreement carefully and compare the terms and conditions of various HELOC's. Pay attention to the APR and the costs and fees to establish the plan. The APR you are quoted often does not include any closing costs or other charges, so make sure you compare these costs as well.

HELOC's usually have variable interest rates. This rate will be based on a publicly available index, such as the prime rate which is published in the Wall Street Journal. The interest rate will change as the index changes. Most lenders charge a set number of percentage points over the index - this is called the margin. For example, your interest rate could be 1.75% plus the index rate. Pay attention to what index and margin the lender uses and how often the index changes. See how high the index has risen, so you will have a worst-case scenario idea of how high your interest rate may go.

Many lenders offer teaser rates. These rates are discounted for a certain amount of time, like an introductory period. After the introductory period is up, the interest rate will reset to the index plus loan margin.

HELOC's usually include a cap on how high the interest rate can rise over the life of the loan. This protects the borrower from sky-high interest rates. Many variable-rate plans will limit how much the interest rate can increase and how much it can fall.

Many lenders will allow a borrower to convert from a variable interest rate to a fixed rate during the life of the loan. Most will allow you to convert the line from a HELOC to a fixed-term installment loan.

Other types of loans will allow the lender to reduce your credit line under certain circumstances. These loans sound restrictive, but actually protect the borrower from borrowing more than they can afford during periods of high interest. Some variable-rate HELOC's will not allow a borrower to borrow any additional funds while the interest rate is equal to the cap on the line.

The cost of a HELOC

When taking out a HELOC, you will probably feel as if you are buying a home. Many of the costs are the same as when you take out your primary mortgage. You will have to pay for a property appraisal to determine the value of your home. There will be application fees, points and closing costs. You may also be charged yearly membership fees or maintenance fees as well as transaction fees each time you use the credit line.

HELOC's often cost hundreds of dollars just to establish. If you are only planning on using a small amount of the line or want to have it "just in case," the costs could be a little too expensive. On the other hand, the lender will usually offer you a lower interest rate on a HELOC than found on other types of credit. The interest saved often offsets any upfront costs. Many lenders do not charge closing costs in order to draw in your business.

The responsibility behind a HELOC

You should never take out any type of loan without knowing how you will pay back what you owe. Many plans will set minimum payments that cover a portion of the principal and the accrued interest, much like a credit card. Other plans only require you pay the interest accrued. These plans usually leave borrowers still owing quite a bit of principal, if not all of it, when the HELOC expires.

Most lenders will give you a choice of payment options. Many consumers choose to pay down the principal regularly, just as with other types of loans. For example, the simply pay as much as necessary to pay off the loan within a set amount of time - like an installment loan.

Keep in mind that in most cases when the plan ends, you have to pay the entire balance owed. Yes, you may be able to refinance it or take out a loan to cover the balance, but you don't know that for sure. Situations change over time. You must be prepared to make the payment. If you are unable to, you face losing your home.

Remember that with a variable interest rate, your monthly payments will change over time. Your payment could increase significantly in just a few years, or it could go down. That is the risk of variable interest rate loans. Make sure that you aren't borrowing more than you can pay back. Calculate what your payment would be if the variable rate hit the loan cap and make sure that you can afford that maximum payment.

When you sell your home, you will be required to pay of the HELOC in full, just like a mortgage. If you are planning on selling your home in the next couple of years, take the time to see if it makes sense to pay the up-front costs of the HELOC. If you plan on using the property as an investment, there are additional considerations. Most lenders will not allow HELOC's on homes that will be rented out or leased.

HELOC's versus second mortgages

A popular alternative to a HELOC is a traditional second mortgage loan. A second mortgage, also known as a home equity loan, offers additional security through a fixed payment over a fixed period of time. The money is usually taken out as a loan in a lump sum. This type of loan is a good choice for those who need a set amount of money for a specific purpose, such as a remodeling project or home improvements.

When comparing the two loan products, keep in mind that the APR is calculated differently for a second mortgage. With a traditional second mortgage, the APR includes the points and other finances charges. A HELOC APR is a variable rate based on the periodic interest rate. It will not include points and other costs.

Pay attention to the lender disclosure

Lenders are required by law to disclose the terms and costs of HELOC's. These terms are required by the Truth in Lending Act. You should be notified of the APR, miscellaneous charges, the payment terms and the interest rate features. You can not be charged any fees until you receive this information. Most lenders provide the disclosure when you receive the application form. You will receive additional disclosures before you close on the loan. If any terms have changed - other than the variable rate - the lender must reimburse you all fees if the change causes you to decide not to borrow through them.

Above all, a HELOC is a loan that should not be entered into lightly. It sounds great, but there is one big disadvantage. You are putting your home at risk. If you default on your loan, you will face losing your home. You have three days from the closing on the HELOC to cancel the credit line. This gives you the right to change your mind. You simply inform the lender in writing within the three days after you sign on the loan. The creditor must cancel the loan and return all fees paid in opening the account, including appraisal fees and application fees.