A home equity line of credit is a type of revolving credit in which the home is used as collateral. Because the home is more likely to be the largest asset of a customer, many homeowners use their home equity line of credit for major items such as home improvements, education, or medical bills rather than day-to-day expenses.
With a home equity line of credit, the borrower is allowed to borrow a specific amount of credit. However, there is a credit limit that the lender sets by taking a certain percentage of the home’s appraised value and subtracting it from the existing mortgage’s balance.
The fixed amount of money repayable by a second mortgage is done over a fixed period of time. In many cases, the payment schedule calls for payments of equal amounts to be paid throughout the entire loan period. One may decided to take a second mortgage rather than a home equity line if, for example, the set amount is needed for a certain purpose such as building an addition onto the home.
However, deciding which type of loan suits the need of the customer involves considering the costs that come along with two alternatives. It is important to look at both the APR and all other charges. The APRs on the two different types of loans are figured in different ways:
Some plans have minimum payments that cover a certain portion of the principal, the total amount borrowed, plus any accrued interest. Unlike the usual installment loan, the amount that goes toward the principal may not be sufficient enough to repay the principal amount by the end of the term. Other plans may allow payments to be made on the interest a loan during the life of the loan, which is referred to as interest-only loans. This means that the borrower pays nothing toward the principal. If the borrower borrows $10,000, that means they will owe that amount when the plan comes to an end.
The borrower may choose to pay an amount higher than the minimum payment, so many lenders may offer a choice of payment options. Many consumers choose to make payments on the principal on a regular basis just as they do with loans. For example, if the consumer uses their line of credit to buy a boat, they may want to pay it off just as they would a typical boat loan, which saves more money in the long run.
Whether the payment arrangements during the life of the loan is to pay a little or pay none toward the principal amount of the loan, when the plan comes to an end the consumer may be required to pay the entire balance all at once. The consumer must be prepared for this “balloon payment” by refinancing that amount with the lender, by obtaining a loan from a new lender, or by other means. If the consumer is unable to make the balloon payment, then they risk losing their home. The consumer must consider how the balloon payment is going to be made prior to entering the loan agreement.
There are several reasons as to why the consumer should consider a home equity line of credit and many different reasons as to why borrowers use them:
Depending on the creditworthiness of the borrower and the amount of outstanding debt, the home equity lender may let the borrower borrow up to 85% of the appraised value of the home minus any amounts still owed on the first mortgage. The lender should be asked about the length of the home equity loan and if there is a minimum withdrawal requirement, as well as if there is a minimum amount or maximum amount to withdraw after the account is opened. The borrower must know in what methods the credit line can be accessed such as credit cards, checks, or both.
There are both advantages and disadvantages to a home equity line of credit. The following are things to look for when considering such an action: