Have you been thinking about financing your child’s college education, paying off some debt, or making home improvements? If you have equity in your home, you have options for tapping into that equity to cover the planned costs. There are two primary ways to do so: obtaining a home equity loan or a line of credit known as an installment loan. With a home equity loan, a lender will advance the total amount needed up front, while a home equity credit line offers you a source of funds for you to access as needed. So which one is right for you?
A home equity loan is given for a fixed amount of money which is secured by the equity in your home. This money is advanced to you, and monthly payments, (similar to your original mortgage payment) are made to the lender over a fixed period of time. Generally banks will loan you up to 85 percent of the home equity; however it is also dependent upon other factors, such as the current market value of your home, your credit history, and total income. While this option may sound good, simply understanding the monthly payment and interest rate for these loans is not sufficient. For example, the annual percentage rate (APR) on the loan generally includes points and other financing charges, including application and processing fees, underwriting fees, home appraisal fees, documentation, and recording fees. You should be aware of all fees included in the home equity loan up front because these fees could mean higher costs.
On the other hand, an installment loan, or home equity line of credit is a revolving line of credit, similar to a credit card. You are allowed to borrow as much as you need, when you need it simply by writing a check or using a credit card associated with that line of credit. Because an installment loan is a line of credit, you only make payments on the amount you borrow, instead of the full amount of funds made available to you. Like a credit card, you are not allowed to exceed the credit limit given by the lender. This line of credit, like the home equity loan, is secured by your home; and you are generally allowed to borrow up to 85 percent of the equity in your home (again depending on other factors, such as credit worthiness).
Similarly, with an installment loan, your line line of credit usually will include the same costs as a home equity loan (or your original mortgage loan) such as points, title search, application fees, and so on. Additionally, with these types of loans, there may be other costs incurred throughout the life of the credit line, such as transaction and membership fees. Moreover, if your credit line has a variable interest rate, you may find your payments increasing on the amounts you have borrowed, so you should find out how much (and how frequently) your payments may change. Finally, you should ask the lender if there are any balloon payments – or a lump sum payment – which is due at the end of the loan. If so, find out what that payment is up front. If you cannot afford to make the balloon payment, you may find yourself borrowing more money against your home to make that payment, or even worse – having to sell your home. Once your line of credit has been opened, a lender may not change the terms of the loan, accelerate the loan, nor cancel the line of credit, provided you have been paying as agreed.
So which one is right for you? That depends entirely upon your needs. Do you need a lump sum of money to put an addition on the house? You may want to go with a home equity loan. Are you looking to tap into the equity periodically for costs, such as paying for your child’s college expenses for the semester? An installment loan may be the better option. Once you know which one you need (a lump sum, or periodic access to the equity) do your research thoroughly. It literally pays (in terms of savings) to shop lenders to compare APRs, points, and other fees. Finally, with both types of loans, it is important to remember that late or missed payments may put your home at risk, so borrow only what you need.
