|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.
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
"A lot of banks, including Wachovia, are starting
to use credit scoring and other statistical things in order to ascertain
whether 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."
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 of time.
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,
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
"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.
-- Updated: Nov. 11, 2002