Home equity loans and lines of
credit are some of the most popular home loans around, but dangers do exist.
Here is how home equity borrowing
works. You take out a loan against the equity in your house in one of two ways.
You either obtain a straight loan that gives you a lump sum of money, or you have
the money set aside as a reserve line of credit that you can tap into when you
Let's assume you still owe $25,000 on your mortgage,
and an appraisal shows the market value of the house is $125,000. Subtract what
you owe from your home's market value, and the difference is $100,000. Since many
banks will grant you a home equity loan or line of credit up to 80 percent of
your equity, in this scenario, you can borrow up to $80,000.
loan deal may sound great, but you shouldn't borrow that much when you have to
make monthly payments on the $80,000 loan in addition to your regular mortgage
payment. The two payments could strangle your wallet!
if you don't make the payments on time, it is foreclosure time and the bank owns
Lenders often use an introductory rate to lure you
to home equity loans. The rate may last for six months to one year. But after
the introductory period, the rate will jump to the bank's prime rate plus anywhere
from 1 to 3 percentage points.
With a straight home equity
loan, the rate is fixed from the start. You pay back the money in fixed monthly
installments. By contrast, a home equity line of credit works like a revolving
credit account, similar to credit cards.
The monthly payment
on a line of credit is usually about 2 percent of the total outstanding principal
amount of the loan. To use a simple example, if you borrow $10,000 at 10 percent,
your first monthly payment is $200. Of that $200, $83.33 is interest and the remaining
amount is used to reduce the loan amount. At the end of a year, you will have
paid $938.26 in interest.
As with credit cards, interest can
be added to your balance. Be careful as your interest rate adjusts that the monthly
payment covers monthly interest payments or your balance will only go up.
you're an ace at handling temptation, don't sign up for a home equity loan that
comes with a credit card attached. The card lets you tap into your home equity
as fast as you can pull out your wallet.
A home equity loan
is a good choice for emergencies and for buying big-ticket items you could not
ordinarily afford. It's also a great way to consolidate your bills at an interest
rate substantially lower than the one banks charge for credit cards. However,
it is important to be aware how the common---and expensive---pitfalls of a home
equity loan can affect your wallet.