Home Equity Loans & Lines in a Nutshell
Two Ways to Tap Home Equity
A Home Equity Loan, like a conventional fixed-rate mortgage, gives you:
- A lump-sum payment.
- A fixed interest rate.
- A fixed number of years to repay, usually 5 to 15 years.
- Fixed monthly payments.
A Home Equity Line of Credit, like a credit card line of credit, gives you:
- A line of credit.
- A variable interest rate, such as 2% over the rate on U.S. Treasury bills (a “margin” over an “index”), with limits on how much and how fast the rate can rise.
- Variable monthly payments based, like credit card payments, on the amount drawn out, the current interest rate, and loan repayment plan – often a 25-year repayment or “interest only” plan.
Home Equity Loans & Lines of Credit are attractive because they generally have:
- Low, tax-deductible interest rates.
- Little or no closing costs, or other fees and charges.
What You Might Get, What You Might Owe
What You Might Get Today & Owe Today and Tomorrow
If your credit is good and your local housing market is reasonably stable, banks today will generally let you borrow 1) up to 80% of your home equity if 2) the payment plus your other fixed payments (the mortgage, real estate taxes and insurance, other debt payments, and items like alimony and child support) takes less than 45% of your income.
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But Consider the Risks!
Because the Risks Are Serious
Should Home Prices Drop
- The bank could reduce or freeze your Line of Credit should the value of your house drop “significantly,” limiting or eliminating your ability to draw out more cash.
- It could become difficult to refinance your first mortgage as you generally need permission from the bank that holds your loan or line of credit, and that bank could demand that you pay off some or all of what you owe.
- It could become difficult to move as you would have less equity to cover the cost of selling, moving, and buying another house.
Should Interest Rates Jump
- Home Equity Line of Credit have caps on how much and how fast your rate can rise. But if your current rate is 4% and could rise 6 percentage points, you could be paying 10% within a few years, and your monthly payment could:
- Nearly double with a 25-year repayment plan.
- Nearly triple on an interest only plan.
Should You Fail to Make Your Payments
- You could lose your house.
Right For You?
Home Equity Loans & Lines Make Sense If:
- You can use the funds to pay off or avoid high-interest debt.
- You need a line of credit for emergencies.
- You have enough reliable income or assets so you can pay back the loan.
For more information, check out the Federal Reserve’s Guide to Home Loans.
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