Home Equity Line of Credit - Important Factors
So, the most important factor to consider before getting started with looking into home equity loans is whether or not you can afford both your mortgage payments and the additional costs of the equity loan. If not, your home could be in jeopardy. If you can afford both loans, this is an excellent way to acquire extra funds for a home remodeling project, the purchase of a new car or even money for a vacation.
Another important factor to keep in mind is how much equity you currently have in your home. The basic way that most lending institutions calculate this is by determining the difference between how much your home is worth and how much you currently owe on the home. For instance, if your home has recently been appraised at $150,000 but you still owe $110,000, you can take out $40,000 on a home equity loan.
The unfortunate part for some new homeowners is that a home equity loan is not a feasible option unless they have had the home for several years or put down a large down payment at the time of purchase.
There are two different types of loans associated with home equity: one of course is referred to as a "home equity loan", while the other one is referred to as a "home equity line of credit". So, what is the difference between the two and which one would be best for your situation? A home equity loan is a lump sum of money that has a fixed interest rate, payments each month and is paid off over a certain period of time. The set amount that you ask to borrow on this type of loan is the amount you will receive.
A home equity line of credit, often called an LOC or a HELOC, works in a similar fashion as a credit card. There will be a set amount on your LOC and the loan will be given for a certain period of time. If you have a $40,000 limit, you can spend up to that much on your account, as long as you repay it by the designated period of time. Once you begin paying the principal portion off, you can use the credit again as needed. Typically, there are different draw periods and there are different repayment periods revolving throughout the life of the loan. During the draw periods, the borrower is only required to pay the interest, although they can elect to pay the principal if desired.
Obviously, a line of credit allows for more flexibility than a one time home equity loan. But a home equity loan may be your best bet if you are simply looking to do a small remodeling project. Opening a line of credit may open you up to spending more money, in a similar fashion to a credit card. As well, lines of credit usually have a variable interest rate that will fluctuate during the life of the loan, while home equity loans almost always have a fixed rate.
A misconception that many people have regarding equity loans is that the borrower has to go to the lending institution where they received their first mortgage. This is not true. You have the freedom to shop around at other lending institutions for varied interest rates. Currently, interest rates for an equity loan range between 4.7% and 5.5% if you have a good history of payment on your mortgage and a good credit history.
Keep in mind when you are determining how much you want to use from your equity account that the equity loan needs to be paid in full at the time the house is sold. If you are planning on selling your home anytime soon, the amount of equity will need to be paid off or rolled into the overall cost of the house.