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Acting much like a second home mortgage (but often with lower interest rates)
a home equity loan is a program which offers a homeowner up to 85% of their
home's current equity in the form of a large sum loan. Interest is accrued
and a monthly payment structure is set up, just like a standard mortgage loan.
Yet instead of a standard home loan, money from a home equity loan can in most
instances be used to pay for anything: home remodeling, college tuition costs,
medical bills, business expenses, a new car, family vacation ... In most
programs, there are no restrictions. And to apply, homeowners must only submit
to a credit check and pay for the bank or lending institution to perform a home
appraisal. Other fees and requirements may apply, but are usually nominal.
A home equity line of credit (HELOC) is granted
using the same percentage system as a home equity loan and requires the same
documentation-credit check, home appraisal-yet a HELOC is issued in the form
of a credit card or checkbook with a limit (much like a standard credit card
account). While some lenders issue annual HELOC fees for having an account open,
others simply charge as you spend the money, with accrued interest. Therefore,
your monthly payments differ based on the amount you have spent. As you pay
down the limit, more funds become available, and so on. And, just like the home
equity loan, most home equity lines of credit allow borrowers to use the money
for whatever they wish.
Pros and Cons
Home equity loans have been hailed as one of the most flexible and desirable
lump sum loan programs, primarily because of the low interest rates and tax
advantages. Yet they are perhaps the most advantageous to those who need a lot
of money and fast-such as for a short-term, large-scale project or medical
bills.
HELOCs, on the other hand, are best utilized by people who might need a large
amount of money over a span of time-such as college tuition or home remodeling
projects that require long-term payments. HELOCs act in much the same ways as
credit cards-but with a few distinct advantages. First and foremost are
the interest rates, which are often much, much lower than standard credit card
fees and rates. Home equity line of credit rates begin at an interest rate that
is less than prime, while credit card rates have been known to reach into the
upper 20th percentile. That's a big difference.
Perhaps this is why home equity loans and home equity lines of credit have
become such popular forms of debt consolidation programs. Credit card debt can
be paid off with the low interest rate from a home equity loan or home equity
line of credit, and then wrapped up into their low interest monthly payment.
Lastly, a considerable advantage for both HELOCs and home equity loans is that
they can have tax advantages, including deductible interest. (Check with your
tax accountant or CPA for more information.)
The downside to both loan programs is that they use your home as collateral,
meaning that if you default on the loan for any reason, your home could be put
at risk. Be sure that you're financially able to at least make the minimum monthly
payments before signing up for such a program-regardless of how good it might
sound.
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