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Home Equity & HELOC |
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Using the roof over one's head as collateral for sizable amounts of credit has become an extremely popular and efficient way to borrow. Equity is the difference between your home's appraised -- or fair market -- value and your outstanding mortgage balance. If you have equity in your home, borrowing against it might be a very effective way to get some things you need at a good price.
When tax changes in 1986 eliminated deductions for most consumer purchases, home equity loans became a way to buy goods and still get a deduction. Let's say you bought your home for $95,000 and made a 20 percent down payment of $19,000. You then took a first mortgage to pay the remaining $76,000. On the day you closed on your home, you automatically had 20 percent equity. You gain equity as you pay off the principal and your home grows in value.
Let's say you've paid $12,000 toward the principal and your property -- valued at $95,000 when you bought it -- is now worth $115,000. Your beginning equity ($19,000), plus the principal you have paid ($12,000) and the increase in your property value ($20,000) gives you $51,000 in equity. There are two types of home equity loans: term, or closed-end loans, and lines of credit.
Both are sometimes referred to as second mortgages, because they're secured by your property, just like your original (first) mortgage. Home equity loans and lines of credit are usually for a shorter term than first mortgages. The most common type of mortgages runs 30 years, while equity loans typically have a life of five to 15 years. A home equity loan, sometimes called a term loan, is a one-time lump sum that is paid off over a set amount of time, with a fixed interest rate and the same payments each month. Once you get the money, you cannot borrow further from the loan.
A home equity line of credit (HELOC) works more like a credit card. You are allowed to borrow up to a certain amount for the life of the loan -- a time limit set by the lender. During that time you can withdraw money as you need it. As you pay off the principal, your credit revolves and you can use it again. Let's say you have a $10,000 line of credit. You borrow $5,000, but then pay back $3,000 toward the principal. You now have $8,000 in available credit. This gives you more flexibility than a fixed-rate home equity loan.
Credit lines have a variable interest rate that fluctuates over the life of the loan. Payments will vary depending on the interest rate and how much credit you have used. When the life span of a line of credit has expired everything must be paid off. A lender may or may not allow a renewal.
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