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Home equity loans and lines of credit: Similar loans, different purposes

Getting one's hands on an extra pile of cash has seldom been easier for homeowners than it is today, thanks to the recent deluge of home equity lending offers. Indeed, both lines of credit and traditional home equity loans, or second mortgages, can help make planned house repairs and additions a reality.

Consider several things
Yet consumers should consider several things before jumping into either financing product, experts say. That's because home equity lines of credit typically are a good deal for those who want a lower up-front rate and access to money at unpredictable times. However, home equity loans are better suited to those who need a specific amount of money and payment stability.

"With a home equity line of credit, you can open it and you're only going to pay for the amount of money you use," says Peter Traum, a Morristown, N.J., branch manager for KeyCorp's Champion Mortgage lending subsidiary. "With a second mortgage, you're going to get a check, and you're going to make payments until you pay that amount off."

Both lending devices use a borrower's house as collateral, with lenders in either case assessing the property to determine how much they are willing to extend. The amount is determined by taking the assessed value and multiplying by a percentage figure, known as the loan-to-value ratio. Traditionally as high as 80 percent, that maximum ratio climbed to just over 90 percent in 1997.

For example, a lender evaluating a $100,000 house with $40,000 still outstanding on the first mortgage would multiply its value by 90 percent. The company would then take the $90,000 result, subtract the outstanding debt, and allow the borrower access to as much as $50,000 in credit.

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Closing costs
Once the amount to be borrowed is set, a homeowner should next consider closing costs, which lenders say are roughly the same for both loans and credit lines. Borrowers may pay as little as $150 or as much as $800, though banks will sometimes waive fees for those who carry a large enough outstanding balance or maintain one for a sufficient amount of time.

As for the time involved, the application process will usually take one to two weeks from start to finish.

But that's where the similarities between the two lending products ends.

Homeowners with lines of credit only have to endure the application process once because they can write checks as needed up to their credit limit, rather than obtain multiple fixed-amount loans. In fact, they typically face only lender-financed credit reviews every one to three years to keep the lines open, and they usually don't even have to talk to their bank at that time, says Garry Fisher, a senior vice president in Wachovia Corp.'s retail product management division.

"A lot of banks, including Wachovia, are starting to use credit scoring and other statistical things in order to ascertain whether or not they even have to contact the customer," Fisher says. "They can just buy a credit score from a (credit) bureau or use an internal customer score."

Annual fees
Credit line upkeep can still lead to annual maintenance fees similar to those charged by credit card issuers, and some borrowers will also be charged fees if they don't use the line for a long enough period.

The rate benefit of lines of credit can help offset those costs. The credit line rate is often even lower for at least some period because stiff competition among lenders has spurred many to offer introductory teaser rates and other incentives. To check local rates in your neighborhood, click here.

Despite all the benefits of a line of credit, experts still advise people who need to make purchases of predetermined amounts to go with a home equity loan. That is in part because payments will be locked in at signing, rather than fluctuate along with the outstanding balance.

"With that home equity loan, the rate is fixed and etched in stone for the life of the loan," Champion's Traum says.

Home equity loan borrowers also will know in advance what their payments are, allowing for a more disciplined approach to paying back the lender. Either way, homeowners should make sure they really need the money since lenders can seize their homes to settle a debt if necessary.

-- Posted: April 7, 2003


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