If you need a significant chunk of money and are unwilling to borrow it or to charge it on your credit cards, what can you do? If you're a homeowner, you may be able to tap the power of a home equity loan or a home equity line of credit, or HELOC. But don't do so without learning more about them. Here are some of the key things to know.
- There are two main kinds of home equity borrowing: a home equity loan secured by the equity in your home and a HELOC. With the former, you borrow what you need in a single lump sum, while the latter allows you to borrow various sums over time as needed. The former has a fixed repayment schedule, while the latter is more like having revolving credit via a credit card. The former will often sport a fixed interest rate, while the latter is more likely to have a variable rate.
- That interest rate will depend in part on how credit-worthy you are. Those with high credit scores (such as in the 700s and above) can expect to be offered the best rates for home equity loans and HELOCs. Those with less pristine credit records will fare less well. Those planning on taking out home equity loans should check their credit reports and scores well before doing so in order to have time to correct any score-lowering mistakes. Note, too, that the rates, terms, and fees that make up the deal you're offered will vary by lender, so do shop around. Don't focus solely on the interest rate.
- Another consideration is that home equity loans and HELOCs can be easier to qualify for if your credit is poor. The terms might not be fabulous, but you may not have many more attractive options.
- Interest rates for home equity loans and HELOCs tend to be higher than those for regular mortgages, but they're also generally considerably lower than some alternatives, such as credit card debt. Thus they have some appeal when you need money.
- Not so long ago, before the recent credit crisis, lenders would often permit people to borrow more than 100% of the value of their home. Now they're being a little more careful, and you should expect to be able to borrow up to about 85%. Some lenders will calculate your maximum by taking a percentage of your home's value and then subtracting what you still owe on it. So if they have a limit of 80% and your home is valued at $100,000, your maximum possible loan value is $80,000. But if you owe $50,000 on the home, you're now looking at a limit of up to $30,000.
- Of course, you shouldn't aim for the maximum, as defaulting on a home equity loan can result in the loss of your home. That's a big deal and should factor heavily in your decision making.
- Know, too, that a lender can cancel a HELOC before you're done using it, which can cause financial pain. Home equity loans are sturdier, with various terms locked in.
- Meanwhile, if you sell your house while you've borrowed against it, you'll be expected to pay off those debts pronto.
- A home equity loan can be canceled within three days of being taken, per federal law, if it's secured by your primary home.
- Interest paid on home equity loans is generally deductible, up to $100,000 in home equity debt.
- Some unscrupulous lenders out there prey on naive or older borrowers. The Federal Trade Commission has said to watch out for practices such as encouraging you to borrow (or refinance) often; adding other products to the loan package, such as insurance; ignoring your ability to pay and lending you too much so that you end up losing your home; or simply charging excessive fees. Another racket is a self-described handyman ringing your bell and offering to make repairs or renovations while helping you secure financing through some connection.
- Sometimes the borrower is the one making the regrettable move. For example, home equity loans taken out to finance renovations may not make your home sell for as much as expected. Borrowing via home equity loans or HELOCs in order to pay off other, higher-interest debt can be effective, but only if you have the discipline to pay the new debt off. Otherwise, you can keep spiraling deeper into debt.
Home equity loans and HELOCs can make your financial life much easier or much worse. Use them prudently -- and learn more before jumping in.