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If you're a homeowner, you can borrow against the value
of your house through either a home equity line of credit (often called
a HELOC or a line) or a home equity loan (often called a HEL or loan).
Both are essentially a second mortgage.
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What's the difference?
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A HELOC is a form of revolving credit similar to a credit
card. It allows you to draw funds, up to a predetermined limit, whenever
you need money. There is generally a minimum payment due each month, with
the option to pay off as much of the line as you want. With a HEL, you
receive a lump sum of money and have a fixed monthly payment that you
pay off over a predetermined time period. In each case, the amount you
can borrow is based on factors such as your income, debts, the value of
your home, how much you still owe on your mortgage and your credit history.
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| Benefits |
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of these types of loans is their interest rates, which are almost always
lower than those of credit cards or conventional bank loans because they
are secured against your home. In addition, the interest you pay on a home
equity line or loan is often tax deductible (consult a tax advisor about
your particular situation). |
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Which is best for you?
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Generally, a HELOC is a good choice to meet ongoing cash
needs, such as college tuition payments or medical bills. A HEL is more
suitable when you need money for a specific, one-time purpose, such as
buying a car or a major renovation.
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Comparing the costs
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Both HELOCs and HELs usually carry a higher interest
rate than that of a first mortgage. With a HEL, you may choose either
an adjustable rate that fluctuates according to variations in the prime
rate, or you may opt for a fixed rate. A fixed rate enables you to budget
a set payment monthly without worrying about increasing costs should interest
rates rise. With a HEL, there are also closing costs that you should consider.
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A HELOC usually carries a lower initial interest rate
than a HEL, but its rate fluctuates according to the prime rate, so there
is more interest rate risk. Unlike a HEL, where your monthly payments
are a set amount, a HELOC enables you to borrow funds as needed and repay
as little as interest only each month. In addition, there are generally
no closing costs when you open a HELOC.
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Keep in mind, your home is the collateral for
both a HELOC and a HEL. If a HELOC's easy access to cash tempts you to run
up more debt than you can repay, or if you fail to make your payments, you
risk losing your house.
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Home Equity Line of Credit (HELOC)
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Home Equity Loan (HEL)
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What you get
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Revolving credit, with a specific credit limit
of up to 100 percent of the value of your home (its value minus
all debts against it). Some lenders will allow you to borrow up
to 125 percent of the value of your home.
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A fixed amount of money, up to 100 percent of
your equity in your home (its value minus your first mortgage debt
and other debts). Some lenders will allow you to borrow up to 125
percent of the value of your home.
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How to qualify
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You typically need to provide proof of your income,
home ownership, your mortgage and how much equity you have in your
home. An appraisal is usually required as well.
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You typically need to provide proof of your income
and home ownership, and proof that at least 20 percent of the value
of your home is paid off. An appraisal is usually required as well.
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How you repay it
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Minimum payments (as little as interest only)
each month; eventually you have to repay the entire sum borrowed
plus interest.
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Fixed payments of interest and principal over
a fixed period of time.
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How long it lasts
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You have a 10- to 20-year period when you can
draw on the line (up to the credit limit), after which you have
a fixed period to pay off the outstanding balance plus interest.
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The term of the mortgage can be as short as a year or as long as
30 years.
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Costs and fees
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Usually no closing costs, but may have an annual
fee.
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Closing costs that are lower than for a first
mortgage.
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How you receive the money
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You draw funds as needed, using special checks
or a credit card.
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You receive one up-front lump sum.
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Interest rate
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The prime interest rate plus a margin (which can
vary from one institution to another).
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A fixed or adjustable interest rate.
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Tax status
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Interest may be tax-deductible (consult a tax
advisor).
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Interest may be tax-deductible (consult a tax
advisor).
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