Home Equity Loan v/s Home Equity Line of Credit

A home equity loan can be borrowed as a one time lump sum payment or obtained as a revolving home equity line of credit, which typicallys works as a regular line of credit. Most people use a home equity loan to pay for large education bills, home improvement costs, unexpected large medical bills or debt consolidation.
Note: Do not use a home equity loan for day to day living expenses, or in paying off small credit card debt. That's just plain stupid!

Qualifying for a Home Equity Loan

After applying for a home equity loan, your lender will assess how much credit limit you are to receive. Your credit limit is the maximum amount of money you can borrow at any given point in time. Your lender will set a percentage point in calculating your credit limit. Use our Home Equity Loan Calculator to determine how credit worth you are! Here's a hypothetical example:

Your Credit line is based on the amount of debt that can be secured by the value of your home. This is calculated as:

Here is the result that our home equity loan calculator would produce:

Your line of credit is based on a maximum debt secured by your home of $195,000 Which is the appraised value of your home times the loan to value ratio. ($325,000 X 60%).

How to Choose the Right Home Equity Loan

You have to know what you are going to use the home equity loan for, if you want to make a good borrowing decision. There are 2 questions you must answer:

i) How you plan to use the money
ii) How you plan to pay it back

Here are general guidelines to follow when borrowing a home equity loan.

i) A fixed one time home equity loan is used for one time cash expenses such as a home improvement (you spending $15,000 to furnish your kitchen), or building a new garden and swimming pool in the backyard.

ii) Home Equity Lines of Credit (HELOC) are better for recurring cash needs such as your monthly student loan payments, monthly medical bills or to pay off that gambling debt.

Tax Advantages of Home Equity Loans

Home equity loans can be advantageous to your financial life if you borrow the right one. The interest payments you make on the home equity loan is tax-deductible from your annual employment/business income. The government allows you to deduct the interest you pay on the first $100,000 of your loan.

Interest Rates & Home Equity Loans

The interest rate on your home equity loan will typically be a variable interest rate that fluctuates up and down based on a Public Index rate. Examples of a Public Index rate are the US 10 year Treasury Bill rate, Prime rate published by the Federal Reserve, etc. When you apply for a home equity loan, the lender will specify in your contract the interest rate you will pay. It usually is the US Treasury Index rate + 2-3% points. This 2-3 percentage points is known as the "Margin."

Costs of Setting up a Home Equity Loan

Getting a home equity loan is a similar process to that of getting a new mortgage. Typical costs include:

- Title search fees
- Attorney fees (for drafting and filing the credit agreement)
- Credit application fee (non refundable fee, even if you get turned down)
- Property appraisal fee (to appraise the current value of your home)

Disclosure of Home Equity Loan Terms

Under the Federal Truth in Lending Act, all lenders are required to disclose to you the specifics of your loan borrowing. Some of these terms include:

- Annual Percentage Rate (APR)
- Good faith estimate of closing costs (see above for a complete list of typical closing costs)
- Interest rate based on the US Treasury Index rate + # of percentage points
- Terms of repayment (whether it will be a one time balloon repayment or variable monthly payments)