| Home equity loans and home equity lines of credit | | | | payment or will your cash needs be intermittent over |
| continue to grow in popularity. According to the | | | | several months or years? Home equity loans are best |
| Consumer Bankers Association, during 2003 combined | | | | suited for one-time payment needs (a good example |
| home equity line and loan portfolios grew 29%, | | | | is consolidating debt by paying off several high-rate |
| following a torrid 31% growth rate in 2002. With so | | | | credit cards at one time). This is because at the time |
| many people deciding to cash in on their home's equity | | | | you close on a HEL, you will be provided with a |
| value, it seems sensible to review the factors that | | | | lump-sum check in the amount you've borrowed (less |
| should be weighed in choosing between out a home | | | | closing costs). While it may be empowering to have |
| equity loan (HEL) or a home equity line of credit | | | | that much money handed over to you, be humbled by |
| (HELOC). In this article we outline three principal factors | | | | the fact that you will immediately begin incurring |
| to weigh to make the decision as objective and | | | | interest costs on the entire balance. |
| rational as possible. But first, definitions: | | | | When you close on a HELOC, on the other hand, you |
| A home equity loan (HEL) is very similar to a regular | | | | will be given a checkbook (or debit card) that you use |
| residential mortgage except that it typically has a | | | | only as needed. So, for instance, if you're embarking on |
| shorter term and is in a second (or junior) position | | | | a multiyear home improvement project for which you'll |
| behind the first mortgage on the property - if there is a | | | | be writing checks at varying times, a HELOC might be |
| first mortgage. With a HEL, you receive a lump sum of | | | | best. Similarly, a credit line is probably best for paying |
| money at closing and agree to repay it according to a | | | | sporadic college expenses. Interest on a HELOC is |
| fixed amortization schedule (usually 5, 10 or 15 years). | | | | only charged from the time that your HELOC checks |
| Much like a regular mortgage, the typical HEL has a | | | | clear the bank and only on amounts actually |
| fixed interest rate that is set at closing for the life of | | | | disbursed...not the value of the entire credit line. |
| the loan. | | | | 3. Do you possess sufficient financial self-discipline for |
| In contrast, a home equity line of credit (HELOC) in | | | | a HELOC? Financially-disciplined borrowers can have |
| many ways is similar to a credit card. At closing you | | | | the best of both worlds...almost. By taking out a |
| are assigned a specified credit limit that you can | | | | HELOC but paying it back according to a self-imposed |
| borrow up to - not a check. HELOC funds are | | | | fixed amortization schedule they can enjoy both the |
| borrowed "on demand" and you pay back only what | | | | flexibility of borrowing cash only as needed and the |
| you use plus interest. Depending on how much you | | | | certainty of a fixed repayment schedule. HELOCs are |
| use the HELOC, you will have a minimum monthly | | | | typically more efficient in terms of lower closing costs |
| payment requirement (often "interest only"); beyond the | | | | and a lower initial interest rate. Also, a HELOC may be |
| minimum, it is up to you how much to pay and when to | | | | somewhat easier for borrowers to qualify for since |
| pay. One more important difference: the interest rate | | | | the low, flexible monthly payments mean debt to |
| on a HELOC is adjustable meaning that it can - and | | | | income ratios that loan officers look at are more |
| almost certainly will - change over time. | | | | favorable for the borrower. |
| So, once you've decided that tapping your home's | | | | The one big factor not within the HELOC borrower's |
| equity is a smart move, how do you decide which | | | | control is the interest rate (see #1 above). Interest |
| route to go? If you take time to honestly assess your | | | | rates will almost certainly change over the life of a |
| situation using the following three criteria, you will be | | | | HELOC. This means that a self-imposed "fixed" |
| able to make a sound and reasoned decision. | | | | amortization schedule may need to be periodically |
| 1. Certainty or Flexibility: Which do you value the most! | | | | refigured. Numerous internet sites provide free, |
| For many borrowers, this is the most important factor | | | | powerful mortgage calculators that can assist you in |
| to consider. Your home is collateral for either type of | | | | preparing updated amortization schedules whenever |
| home equity borrowing and, in a worst case scenario, it | | | | needed. Some lenders are also meeting borrowers' |
| could be seized and sold to satisfy an outstanding | | | | demand for greater certainty by providing HELOC |
| unpaid loan balance. People do remember the | | | | products that can be converted (for a fee) into a fixed |
| double-digit interest rates of the early 1980's and, for | | | | rate loan when the borrower elects. |
| many, the mere prospect of interest costs on a | | | | As mentioned earlier, HELOCs are much like credit |
| variable-rate home equity line of credit rising rapidly | | | | cards and the similarity extends to spending temptation. |
| beyond their means is reason enough for them to opt | | | | If you are a person who has trouble keeping credit |
| for the certainty of a fixed rate HEL. | | | | card debt under control and you haven't taken steps |
| From the borrower's perspective, "certainty" is the | | | | to change habits, then a HELOC probably isn't a smart |
| main virtue of a fixed-rate home equity loan. You | | | | choice. |
| borrow a specific amount of money for a specific | | | | You might be wondering which home equity product |
| period of time at a specific rate of interest. You repay | | | | most people actually choose. According to the |
| the loan in precise monthly installments for a precise | | | | Consumer Bankers Association 2002 Home Equity |
| number of months. For many, knowing exactly what | | | | Study, home equity lines of credit account for 28% of |
| their future obligations will be is the only way they can | | | | consumer credit accounts followed by personal loans |
| borrow against the equity in their home and still sleep | | | | (23%) and regular home equity loans (16%). In terms of |
| at night. | | | | dollar value, home equity credit accounts (HELs and |
| A home equity line of credit, in contrast, is short on | | | | HELOCs together) represent a full 75% of consumer |
| certainty but long on the virtue of flexibility. With a | | | | credit portfolios with HELOCs having a 45% share of |
| HELOC you borrow funds on an irregular schedule | | | | the market and HELs a 30% share. Of course, the |
| that meets your needs at adjustable interest rates that | | | | popularity of HELOCs may subside if interest rates |
| can change quickly. Loan repayment is also flexible: | | | | continue to rise. |
| you typically are required to make only relatively small | | | | Whichever home equity product you decide on be |
| "interest-only" monthly payments on a HELOC. | | | | certain to shop for the best deal possible. The market |
| However, you have flexibility to make any size | | | | is extremely competitive and there are many |
| payment above the interest-only minimum or payoff | | | | non-traditional options, including on-line lenders and |
| the loan at your will. | | | | credit unions, which should be considered in addition to |
| 2. Do you need money for a one-time, lump-sum | | | | your local bank. |