Mortgage loans and mortgage lines of credit continue to grow in popularity. According to the Consumer Bankers Association, during 2003 combined with the online mortgage and loan portfolio grew 29 percent, after a torrid growth pace of 31 percent in 2002. With so many people that the decision to take advantage of the equity value of your home, it seems reasonable to revise the factors to be weighed in choosing between a home equity loan (HEL) or a line of credit (HELOC) loan.
Mortgage loans and mortgage lines of credit continue to grow in popularity. According to the Consumer Bankers Association, during 2003 combined with the online mortgage and loan portfolio grew 29 percent, after a torrid growth pace of 31 percent in 2002. With so many people that the decision to take advantage of the equity value of your home, it seems reasonable to revise the factors to be weighed in choosing between a home equity loan (HEL) or a line of credit (HELOC) loan. This article describes three main factors that weigh in making the decision as objective and rational as possible. But first, definitions:
A home equity loan (HEL) is very similar to a normal residential mortgage, except that usually has a shorter duration and is in a second (or third) place behind the first mortgage on the property – if there is a first mortgage. With a HEL, you receive a lump sum of money at closing and in accordance with pay according to a fixed amortization schedule (usually 5, 10 or 15). Like a regular mortgage, the typical HEL has a fixed interest rate is set at the close of the term of the loan.
In contrast, a line of credit (HELOC) in many ways is similar to a credit card. In closing is assigned a certain credit limit you can borrow up to – not a check. HELOC funds are borrowed “on demand” and pay only what you use plus interest. Depending on how much you use the HELOC, you will have a minimum monthly payment requirement (often “interest only”), beyond the minimum, up to you how much to pay and when to pay. A more important difference: the interest rate on a HELOC is adjustable meaning you can – and almost certainly that – change over time.
So once you’ve decided that tapping your home equity is a smart decision, how do you decide which route to go? If you take the time to honestly evaluate your situation with the following three criteria, you will be able to make a sound and reasoned decision.
1. Certainty or Flexibility: What do you value most?
For many borrowers, this is the most important factor to consider. Your home is a guarantee for any type of home equity loan, and in the worst case, could be seized and sold to satisfy an unpaid balance of the loan. People remember the interest rates of double-digit 1980 and, for many, the mere prospect of interest costs on a line of home mortgage variable rate grows rapidly out of reach, is reason enough for can opt for the certainty of HEL fixed interest rate.
From the perspective of the borrower, the “certainty” is the main virtue of a fixed rate mortgage capital. You borrow a specific amount of money over a specific period of time at a rate of interest. To repay the loan in monthly installments requires a precise number of months. For many, knowing exactly what their future obligations is the only way you can borrow against the equity in your home and still sleep at night.
A line of credit, however, is short on certainty, but always in the virtue of flexibility. With a HELOC you borrow funds on an irregular schedule that meets your needs at adjustable interest rates that can change quickly. The loan repayment is also flexible: usually required to make only relatively small “interest only” monthly payments on a HELOC. However, you have the flexibility to make any size payment above minimum or interest only loan payment to his will.
2. Need money for a one-time lump sum payment or will your cash needs be intermittent over several months or years?
Mortgage loans are best suited for single payment needs (a good example is consolidating debt by paying several high-rate credit cards at once). This is due to the time you close on a HEL, you will receive a lump sum check in the amount you’ve borrowed (less closing costs). While it may be empowering to have that amount of money given to you, be humbled by the fact that it will immediately begin incurring interest costs of the entire balance.
When you close a HELOC loan, however, be given a checkbook (or debit) that you use only when necessary. For example, if you are embarking on an improvement project home to several years for writing checks is a different time, a HELOC may be better. Similarly, a line of credit is probably best for paying sporadic expenses of college. HELOC Loan interest is charged only from the time your HELOC checks by the bank and only on amounts actually disbursed, no … the value of all credit line.
3. Do you have sufficient financial resources to self-discipline a HELOC?
Financially disciplined borrowers can have the best of both worlds … almost. Taking a HELOC but paying it back according to a plan of self-imposed fixed amortization you can enjoy both the flexibility of borrowing cash only as needed and the certainty of a fixed payment schedule. HELOCs are typically more efficient in terms of lower closing costs and an initial interest rate lower. Also, a HELOC can be a little easier for borrowers who qualify for payments from the low, flexible monthly: debt to income ratios that loan officers look more favorable to the borrower.
The only important factor, not under the control of the borrower HELOC is the interest rate (see 1). Interest rates will almost certainly change over the life of a HELOC. This means that a self-imposed “fixed” amortization schedule may need to be reconfigured periodically. Many websites offer free calculators, mortgage powerful that can help you in preparing updated amortization schedules whenever necessary. Some lenders also meet borrower demand for greater certainty, providing HELOC products that can be converted (payment) on a fixed rate loan when the borrower chooses.
As mentioned above, HELOC loans are very similar to credit cards and the similarity extends to spending temptation. If you are a person who has trouble keeping credit card debt under control and have not taken steps to change habits, then a HELOC probably not a smart choice.
You may wonder what is the home equity product most people actually choose. According to the Consumer Bankers Association 2002 Home Equity Study, home equity lines of credit account 28 percent of consumer credit accounts followed by personal loans (23 percent) and regulate secured loans mortgage (16 percent). In terms of dollar value, the home equity credit accounts (Hels and HELOCs together) represent 75 percent of consumer credit portfolios with HELOCs with a 45 percent share of the market and 30 percent Hels . Of course, the popularity of HELOCs may decrease if interest rates continue to rise.
Regardless of the home equity product you decide on be sure to find the best deal possible. The market is very competitive and there are many nontraditional options, including online, lenders and credit unions, which should be considered in addition to their local bank.
Published in: Personal Finance