Mortgage Money Expert

Homeowners can use the equity built up in their home for various financial needs. Some of the popular ways of using the home equity are taking out a home equity loan and getting a home equity line of credit (HELOC). Home equity loans and HELOCs are often confused with each other. Even though both allow you to use the home equity owned by you, there are differences in these products, especially with reference to how the money becomes available in each.

How a HELOC works

A home equity line of credit is a credit line made available with a pre-determined limit. You can borrow from it, as and when you need the money. It works like a credit card, where a limit is specified, beyond which you cannot borrow.

The credit limit offered by lenders is 100% of your home equity value and in some cases can go up to 125%. You have a ten to twenty year draw period where you can access the cash. After this period, you have a fixed time to repay the outstanding balance along with the interest. You can choose between a variable rate and a fixed rate HELOC. In the former, rates can fluctuate depending on the changes in the prime rate. But there is a cap on the rate changes, that is a limit on the amount by which the rate can be adjusted over a specific period. You can transfer from a variable rate to a fixed rate to avoid incremental changes in rates if you like.

A HELOC is ideal to meet ongoing financial commitments such as monthly medical bills or tuition fees. Also, the interest paid on a HELOC is tax-deductible in most cases. Another reason that makes HELOCs so attractive is that there are no associated costs such as closing costs, check-writing fees and usage fees. You have to make a minimal payment each month, though you also have the option to repay as much of the credit line as you wish.

How a home equity loan works

A home equity loan (HEL) is a secured loan taken against your home. A lump sum amount is borrowed to be repaid over a specified time period. The term can be anywhere between one to thirty years. Such loans are ideal for a big, one-time expense such as a large-scale home remodeling.

You can borrow 100 to 125 percent of your home’s equity value. Those who have paid off at least 20% of the home’s value, and have a good credit history and stable income can easily secure home equity loans. Both fixed and variable rates are offered. The rates are generally reasonable and much lower in comparison with credit card interest rates. The payments are amortized, that is equal payments of principal and interest have to be made on a monthly basis to repay the loan. There are closing costs associated with such loans, but they are lower than those charged for the first mortgage. In most cases, the interest is tax-deductible.

Before you take out a home equity loan, carefully consider whether the expense/purchase is worth taking a loan against home equity. A hasty decision could put you in neck-deep debt and in a worst case scenario, lead to a foreclosure.

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