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Fixed-rate
loan vs. line of credit
By Bankrate.com
There are two types of home equity loans: term, or
closed-end loans, and lines of credit.
Both are sometimes referred to as second
mortgages,
because they're secured by your property, just like your original
(first) mortgage.
Home equity loans and lines of credit are usually
for a shorter term than first mortgages. The most common type of
mortgages runs 30 years, while equity loans typically have a life
of five to 15 years.
A home equity loan, sometimes called a term loan,
is a one-time lump sum 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. To see
current home equity loan rates, click
here.
A home equity line of credit (HELOC) works more like
a credit card. You are allowed to borrow up to a certain amount
for the life of the loan -- a time limit set by the lender. During
that time you can withdraw money as you need it. As you pay off
the principal, your credit revolves and you can use it again. Let's
say you have a $10,000 line of credit. You borrow $5,000, but then
pay back $3,000 toward the principal. You now have $8,000 in available
credit. This gives you more flexibility than a fixed-rate home equity
loan.
Credit lines have a variable interest rate that fluctuates
over the life of the loan. Payments will vary depending on the interest
rate and how much credit you have used. When the life span of a
line of credit has expired everything must be paid off. A lender
may or may not allow a renewal. To see current home equity line
of credit rates, click
here.
Lines of credit are accessed
by specially issued checks or a credit card. Lenders often require you to take
an initial advance when you set up the loan, withdraw a minimum amount each time
you dip into it and keep a minimum amount outstanding. Financial
institutions negotiate a home equity loan just like they do a mortgage: You have
to pay off the loan or line of credit when you sell the house. Which
type should you choose?
The answer to this question is seldom black
and white. But there are some scenarios where the choice is
obvious. For example, let's say you need $7,000 to pay for your daughter's wedding
next month and $3,000 to fix your roof, which will take a week. You know exactly
how much you need and both amounts are due in full fairly quickly. If you don't
have plans to borrow again, a straight home equity loan for $10,000 is more suited
to your purpose. But if you need money over a staggered period
of time -- for example, at the beginning of each semester for the next four years
to pay for Jimmy's schooling or for a remodeling project that will take three
years to finish -- a line of credit is the better choice. It gives you the flexibility
to borrow only the amount you need, when you need it. And
if you borrow relatively small amounts and pay back the principal quickly, a line
of credit can cost less than a home equity loan. Consumers
who have run up credit card debt will often borrow a lump sum and pay off their
Visa, MasterCard and department store charges, then pay back the bank over time
at a lower interest rate than the cards would have imposed. This sort of debt
consolidation is the single most-popular reason people have for taking out home
equity loans, and fixed-rate home equity loans are used slightly more often for
this purpose lines of credit. To help you determine which
loan best suits your needs, ask yourself: - When do I
need the money?
- For how long do I need the money? Is it for a
short-term purpose, or a long-term?
- How long do I need to pay
it off?
- How big a monthly payment can I handle?
- Would
a line of credit tempt me to use the money carelessly because it works similar
to having a charge card or checking account?
Ask your lender:
- How long is the term of the closed-end loan?
-
What is the life span of a line of credit?
- How large a line of
credit do I qualify for?
- Is my line of credit renewable when
the life of the loan expires?
- What are the interest rates?
- Do
I have to use my credit line right away? (If you're opening a credit line for
future or emergency needs, you'll want one that doesn't require a minimum draw
at closing.)
- Under what circumstances can you freeze, reduce
or demand full payment of my loan?
- Can I lease my house during
the time of the loan?
- Will you loan to me if my house is on the
market (and at what rate)?
- If interest rates go down, how low
will my loan go?
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