Posted on Sep 01, 2016
As we bid farewell to a sizzling hot summer and welcome the clear, blue skies of fall, our attention turns from lounging poolside to taking action. Important projects such as scheduling home improvements, purchasing a new vehicle, consolidating debt, paying college tuition, and getting a home-based business up and running immediately move to the top of the to-do list.
If you have considered tapping into the equity in your home to fund such expenses, you are not alone. A home equity loan or home equity line of credit is a viable option for millions of Americans. These home equity debt options are sometimes referred to as second mortgages, because they are secured by your property, just like the original, or primary, mortgage.
A home equity loan is a one-time lump sum amount that is paid off over a set amount of time, with a fixed interest rate and the same payments each month. Once you get the money, you cannot borrow further from the loan.
A home equity line of credit, or HELOC, works more like a credit card because it has a revolving balance and a variable interest rate. A HELOC allows you to borrow up to a certain amount for the life of the loan -- a time limit set by the lender. During that time period, you can withdraw money as you need it. As you pay off the principal, you can use the credit again, like a credit card.
With either a home equity loan or a line of credit, you have to pay off the balance when you sell the house. And, as the name implies, the amount of the loan or line of credit is dependent upon the available equity in your home. To determine the available equity, you need to know the value of your home and the amount of your existing debt against the property. The difference is the available equity, of which the bank will lend a certain percentage to you. Typically, the total of all loans, or mortgages, against your house should not exceed 90% of the value of the property.
When using your home as collateral for loans, there also needs to be caution. Most importantly, if you cannot make the future payments on your home equity loan or line of credit, you risk losing your house. To avoid this risk, for example, it is not prudent to use your home equity to pay routine bills.
On the other hand, do you need money to fix up your home? If you’re planning to put your house on the market soon, a home equity loan or line of credit may be the best way to finance needed improvements to increase the sale value, and you can then pay if off entirely when you sell. Of course, this option is also a good way to fund improvements if you plan to remain in your house.