Two Types of Getting a Loan with Your Home Equity

Two Types of Getting a Home Equity Loan

There are two main ways of cashing out your home’s equity: Term Loan and Line of Credit.

1. Home Equity Term Loans

This is a close-end installment loan for a fixed amount, which you pay back in monthly payments for a set term – normally between 5 to 15 years. You apply the same way you do for a first mortgage; the closing costs are usually less and the interest rates are usually more. The interest rates can be fixed or variable. Once you've received the lump sum, you cannot borrow further from the loan.

Term loan is more traditional, and often cheaper, way of borrowing against your equity. It enables you to know in advance exactly what your payments will be. However, the flip side is it’s lack of flexibility. You may have serious problems later should you find that you didn’t borrow enough or should you experience cash-flow difficulties.

This loan can be a good choice for:

• A one-time project or purchase
• People who need a specific amount of money and payment stability
• People who want to buy a new home without selling the old one
• People who may not have the self-discipline to handle a line of credit
• Debt consolidation: People often borrow a lump sum against their home equity, pay off their credit cards or store charges, then pay back the bank over time at a lower interest rate than the cards would have imposed.
  

2. Home Equity Line of Credit (HELOC)

HELOC is an open-end home equity loan, which is much like a credit card loan. You get approval of borrowing up to your predetermined credit limit. There are no monthly payments until you actually make use of it. You get a certain number of years during which you can "draw down" you line whenever needed, by writing checks against your total available credit line or using credit cards linked to that line. As you pay back your loan, your credit may be used again. However, you must have paid back the loan in full when the stated time period is up or you sell your house. At that point, your lender may or may not allow you to renew your line of credit.

HELOG is very popular because it is flexible and easy to access; you can tap into HELOG simply by writing checks or using a card. The same advantage, however, can lead you into temptation to overuse them. The low-pressure repayment term can also make the loan very costly and possibly dangerous in that you are not in a rush to repay the debts, which can end up with a huge balloon payment. HELOG is especially dangerous for those who have a history of handling credit poorly because there is always the temptation to tap into it just like credit card debt. You need to make it sure that you limit the use of HELOG to the minimum and repay the loan as soon as possible.

HELOC usually has a variable interest rate that fluctuates over the span of the loan. The monthly payments vary based on the interest rate and how much credit you have used. That makes the loan pretty much complicated and unpredictable.
HELOG can be a good choice for you if you

• Want a lower upfront rate and access to money at unpredictable times.
• Need money over a staggered period of time.
• Are going to borrow relatively small amounts and pay back the principal quickly.
• Are not sure about your future job security. -- If you get a home equity line of credit while you still qualify, you’ll be better able to pay off high-rate credit cards.