Financial Literacy 2007 - Home equity
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home equity
Which type of loan suits you best?

Although several options are available, the most common choice for a home equity loan is between a home equity line of credit, commonly called a HELOC, and a home equity loan.

The loan you go with depends on how financially disciplined you are and whether you need a set amount of funds in one lump sum (home equity loan) or a flexible amount over time (HELOC). Katie Porter, an associate professor of law at the University of Iowa and mortgage bankruptcy researcher, points out that while it may be easier to stick to and budget for a set amount using a home equity loan, "for most people, money left sitting in the bank tends to get spent. On the other hand, if you're going to need multiple infusions of cash, the fees from taking multiple home equity loans will add up and you might be better off with a line of credit."

Here's a quick list highlighting the differences between a home equity line of credit and a home equity loan to guide your decision.

HELOC vs. home equity loan
HELOCHome equity loan
Money is dispersed as needed, may have mandatory dispersal to openTake money in one lump sum
Generally, no closing costsOften carry closing costs
Interest rate is usually variable, subject to ups and downs of ratesInterest rate is generally fixed for life of loan
Generally, interest paid is tax deductibleGenerally, interest paid is tax deductible

The lure of low rates once made the variable-rate HELOC a popular choice over a fixed-rate loan. In today's market, however, the rates are closer and even the loans have become more similar. It can be difficult to compare rates between the two products. The American Institute of Certified Public Accountants (AICPA) site warns: "When comparing a home equity line of credit to a home equity loan, don't rely solely on the annual percentage rate (APR) as a measure of cost, because the APR for a home equity loan takes points and financing charges into consideration while the APR for a home equity line of credit does not."

Stings of HELOC

The prospect of tapping your home equity with a line of credit can be sweet, as long as you know what's involved. Be aware of these potential stings.
  • Interest rate changes with variable rates can be drastic (can quickly become much more expensive).
  • Your credit is subject to credit reviews (every three years, for example) to determine whether to keep the line open.
  • May have hidden fees.
  • If you only pay interest, and not the principal, you'll end up with an expensive balloon payment due at the end of the term.

Antidote for HELOC stings

Check out these tips for smart ways to stay ahead of a HELOC balance.
  • Shop for refinancing options well in advance of the due date, so you won't be rushed into a decision under stress.
  • Find the best home equity loan and HELOC rates offered in your neighborhood at the Bankrate rate tables.
  • Prepay part of the principal each month. Consider paying it down further with any extra money, such as a tax refund or bonus.
  • Make saving for the balloon payment part of your monthly budget. Put the money in a high-yield savings account.

Check out the calculator and work sheets on the Tools page to crunch the numbers and find the best type of loan for your financial needs.

Has home equity funded your dreams or turned into a nightmare? Share your story.

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