Understanding Home Equity Loans & Lines of Credit

One Home – Two Possible Solutions

Home Equity Loans & Lines of Credit are different types of mortgage loans that allow you to tap into your home's equity for your own personal use. Some people have a natural difficulty understanding the difference between these two options and may confuse them, but they are significantly different and you should be aware of these differences and how they can lead to different financial outcomes.

Home equity loans or lines of credit are usually both calculated by the bank in the same way. The lender will seek a qualified, professional appraisal of your home and then come up with a percentage of the appraised amount – most often around seventy-five percent of the appraised value and offer that amount to you as a maximum loan amount. Whether or not you will have any money to actually use will depend on how much you still owe on your mortgage. For example, if your home is appraised at $200,000, the bank will set a figure of seventy-five percent of that amount, or $150,000. If you owe less than $150,000 on your home, then your home's value is sufficiently high enough to justify their offering you a home equity loan or line of credit.

Not all banks calculate this amount in the same way, so you should be sure to check with several lenders before deciding whether or not you wish to pursue a loan with them. If you get rejected at one bank, then try another that may have more favorable terms, allowing you to get the loan you want. Be sure to keep in mind that banks will have differing terms that will affect your loan as well, such as interest rate and how long you will have to repay the loan.

Home Equity Loans

Home equity loans sometimes also referred to as second (or third) mortgages. It is a flat loan amount that is given out much like a traditional loan and would need to be repaid with monthly payments over time as determined by the loan agreement.

Home equity loans, like conventional loans, are governed by two primary figures: the amount borrowed and the annual percentage rate, or APR that determines how much interest will accrue over the account over time. Though the APR may be higher than your original mortgage, it is still going to be substantially lower than most other loan types you can find, due to the secured nature of the loan.

When you apply, and are approved for a home equity loan, you will be offered repayment terms and a contract that specifically spells out your obligations – namely to repay the loan in regular monthly installments for a predetermined amount of time until the loan plus any interest accrued is paid. Failure to pay on a home equity loan gives the bank license to place a lien on your home, meaning you will not be able to sell it without satisfying their debt first.

Home Equity Line of Credit

Home equity lines of credit act like a home equity loan in how they are secured, but not in how they are executed. Rather than being a flat, lump-sum payment loan drawn against the equity in your home, home equity lines of credit act as a revolving accredit account. How much credit you have available will be based on your home's equity and may fluctuate based on market conditions.

You will need to go into escrow and close successfully in order to be approved for a home equity line of credit but once it is done, you will be able to use the credit as frequently and often as you need it as long as there is sufficient equity in your house and you do not spend beyond the limit most recently set by the bank. There may be fees or penalties associated with not using a home equity line of credit for too long a period of time, which means that you are not really free to open an account unless you intend to use it with some regularity. If you have any quesitons, please visit our Frequently Asked Questions page for your answers.