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Home Equity
A home equity line is a form of revolving credit in which your home
serves as collateral. Because the home is likely to be a consumer's
largest asset, many homeowners use their credit lines only for major
items such as education, home improvements, or medical bills and not
for day-to-day expenses.
With a home equity line, you will be approved for a specific amount of
credit-your credit limit-meaning the maximum amount you can borrow at
any one time while you have the plan.
Many lenders set the credit limit on a home equity line by taking a
percentage (say, 75 percent) of the appraised value of the home and
subtracting the balance owed on the existing mortgage. For example:
| Appraisal of home | $100,000 |
| Percentage | x75% |
| Percentage of appraised value | $75,000 |
| Less mortgage debt | -$40,000 |
| Potential credit line | $35,000 |
In determining your actual credit line, the lender also will consider
your ability to repay, by looking at your income, debts, and other
financial obligations, as well as your credit history.
Home equity plans often set a fixed time during which you can borrow
money, such as 10 years. When this period is up, the plan may allow you
to renew the credit line. But in a plan that does not allow renewals,
you will not be able to borrow additional money once the time has
expired. Some plans may call for payment in full of any outstanding
balance. Others may permit you to repay over a fixed time, for example
10 years.
Once approved for the home equity plan, usually you will be able to
borrow up to your credit limit whenever you want. Typically, you will
be able to draw on your line by using special checks.
Under some plans, borrowers can use a credit card or other means to
borrow money and make purchases using the line. However, there may be
limitations on how you use the line. Some plans may require you to
borrow a minimum amount each time you draw on the line (for example,
$300) and to keep a minimum amount outstanding. Some lenders also may
require that you take an initial advance when you first set up the line.
Costs to Obtain a Home Equity Line
Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home. For example:
- A fee for a property appraisal, which estimates the value of your home.
- An application fee, which may not be refundable if you are turned down for credit.
- Up-front charges, such as one or more points (one point equals one percent of the credit limit).
- Other
closing costs, which include fees for attorneys, title search, mortgage
preparation and filing, property and title insurance, as well as taxes.
- Certain fees during the plan. For example, some plans impose yearly membership or maintenance fees.
- You also may be charged a transaction fee every time you draw on the credit line.
Comparing a line of credit and a traditional second mortgage loan
If you are thinking about a home equity line of credit you also might
want to consider a more traditional second mortgage loan. This type of
loan provides you with a fixed amount of money repayable over a fixed
period. Usually the payment schedule calls for equal payments that will
pay off the entire loan within that time. You might consider a
traditional second mortgage loan instead of a home equity line if, for
example, you need a set amount for a specific purpose, such as an
addition to your home.
In deciding which type of loan best suits your needs, consider the
costs under the two alternatives. Look at the APR and other charges.
You cannot, however, simply compare the APR for a traditional mortgage
loan with the APR for a home equity line because the APRs are figured
differently.
- The APR for a traditional mortgage takes into account the interest rate charged plus points and other finance charges.
- The APR for a home equity line is based on the periodic interest rate alone. It does not include points or other charges.
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