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Money January 2014

Home Equity Loans: Freeing up Funds for Seniors, But Be Cautious

By Lynn Pribus

Borrowers must always remember they are taking equity out of their home, which decreases its value. If the house is sold, the loan must be repaid. In addition, failure to repay could result in foreclosure or a short sale.

Home equity loans can be a useful source of cash for homeowners who are considering remodeling jobs, mortgage refinancing, major appliance purchases, or other big-ticket items. They may also be a smart economic move when consolidating existing high-interest-rate loans such as credit card debts. Paying off high-interest loans with a single home equity loan translates into a single monthly payment with a considerably lower interest rate. In addition, the interest on a home equity loan is usually tax deductible.

Still, it is always prudent to fully understand the benefits and risks of taking another loan on your home.

 

What Is a Home Equity Loan?

A home’s equity, of course, is the home’s value minus the existing mortgage balance and any other existing loans. Equity loans take two forms. One is an outright loan which provides a lump sum, generally at a fixed rate for a fixed term. The other is a home equity line of credit which is abbreviated to HELOC (pronounced HE-lock) which provides money as needed and usually has a variable interest rate that may change during the term of the loan because it is tied to the prime lending rate.

Both kinds of loans have additional costs such as appraisals, originator and title fees, closing costs and pre-payment fees. In some cases, the borrower pays, sometimes the lender pays, and sometimes the costs are shared. The closing costs are typically less than for a mortgage.

 

Outright Loans

Generally, people can up borrow up to 90 percent of the equity (not the market value) in a home they occupy and about 70 percent for non-owner-occupied houses. There is a variety of options from five- to 30-year loans. These loans are commonly second mortgages, however if a home is owned outright, the loan would be a first mortgage.

Home equity loans are usually done through banks or credit unions rather than a mortgage company or broker. A repayment schedule, like that of a mortgage, is set up, so the costs are regular and predictable.

 

HELOCs

Line-of-credit loans are useful for providing ready credit for needs that don't require a large one-time payment. Proceeds might be used for long-term renovation projects and the borrower can choose when and how much to borrow. The interest may be tax deductible. As a rule, interest rates are lower than those for an outright loan, however, it's important to remember that variable rates can climb.

Borrowers can use any part of the credit line at any time and payments are made on only the outstanding amount of the loan, not the total available. It's basically similar to a revolving account on a credit card and the money can be used and repaid and used again.

Unlike a credit card, a HELOC is secured by the equity in the home so rates are much lower than an unsecured loan and depend on the repayment option chosen by the borrower. It's common for a borrower to have the option to make full repayment at any time or to just pay the interest. Here are many variables such as the size of loan, the credit profile of the borrower, and whether it's a first or second lien. It's always a good idea to shop around between institutions.

 

Caveats

Borrowers must always remember they are taking equity out of their home, which decreases its value. If the house is sold, the loan must be repaid. In addition, failure to repay could result in foreclosure or a short sale.

HELOCs should be repaid in a relatively short time. A HELOC can be a smart idea when the money is being used to improve the home, but it's not a good way to pay for a car or a big vacation.

Still, for people who handle their finances well, home equity loans can be a practical low-interest way to find money for expenses.

 

Lynn Pribus lives near Charlottesville, Virginia, with her husband and their dog.

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