Home Equity Loans

IF YOU NEED TO BORROW, tapping into your home’s value can be one of the cheaper options. The interest rate will tend to be low, because the loan is secured by your house, though the interest on home equity loans is no longer tax-deductible, thanks to the 2017 tax law, unless the loan was used to buy, build or substantially improve a first or second home.

What sort of loan should you take out? You can choose between a home equity loan and a home equity line of credit. In terms of the interest rate, it’s similar to choosing between a fixed-rate and an adjustable-rate mortgage.

The interest rate on a home equity line of credit, or HELOC, is pegged off short-term rates, just like an adjustable-rate mortgage. Usually, the rate charged by a HELOC is set at some discount or premium to the prime rate. Some banks have introduced HELOCs that offer low fixed rates for a year or more, hoping to encourage customers to use their credit lines. But after that initial period, the rate can change every month, and it could climb quickly if short-term interest rates rise. You won’t be charged interest until you use the credit line. When you first apply for a HELOC, the bank will put a cap on how much you can borrow, such as $50,000 or $100,000. Occasionally, a bank may cancel a credit line or reduce its size.

A HELOC has an initial draw period and a subsequent repayment period. During the draw period, which might last 10 years, you can borrow up to the maximum allowed by the credit line. Payments typically consist of interest only, though you can always pay more and thereby reduce the loan’s principal balance. During the repayment period, which could last 20 years, you can’t draw on the credit line anymore. Moreover, the minimum payments consist of both interest and principal, so you could see a sharp increase in your required minimum monthly payments.

How does a home equity loan differ from a HELOC? The interest rate is typically fixed for the life of the loan, just like it is on a fixed-rate mortgage, and that rate will usually be higher than the rate on a HELOC. That extra cost buys you protection against rising rates. Unlike a HELOC, you have to decide how much you want to borrow. You would then need to repay the loan on a predetermined schedule, just as you would with a fixed-rate mortgage.

A HELOC can be useful both as a source of emergency money and for major expenditures, such as buying a car or remodeling the kitchen. You might also use a home equity loan for major expenditures, especially if you have a firm idea of how much you need to borrow.

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