Consolidating Your Debts – Home Equity Loan or Home Equity Line of Credit

When you have an enormous amount of debt, and would like to consolidate it by using your most precious asset (your home), which would be the best option to take? Home Equity Loan or Home Equity Line of Credit.

I was looking for an answer and I found one basic response that would put it in layman’s terms:

With a home equity loan, you apply for and get a fixed amount, up front and have to repay the loan over a fixed period, such as 15 years.

With a home equity line of credit, you apply for credit up to a certain amount, usually the amount of equity you have in your home. You are then given a stack of checks. You write checks as you need the money. The bank tracks how much you borrowed, figures out a required monthly payment, then sends you a bill. You always have to pay the minimum amount but can pay more if you choose.

The answer is pretty but you have to know the ropes in order to get the best deal. Whether you decide to take out a Home Equity Loan or Home Equity Line of Credit, you would still have to go through the same channels to obtain it.

  • What is your credit score?
    • This is a very important piece in your loan application. If your credit score is low, chances are you will receive a high rate of interest upon approval. Before you even think of applying for a loan, make sure that your credit score is in great shape.
      • Tip : Check your credit score for free (this is a new law and you can obtain your credit report for free once a year) – go to: www.annualcreditreport.com and pull your credit score.
  • How much do you owe?
    • You have to make certain that the amount you will be borrowing combined with your current mortgage will not put you in the hole.
    • If you don’t, you will end up in the same hole that you are in. You will use your cards again, and owe much more again.

Here’s a detailed explanation from www.bankrate.com

A home equity loan or line of credit allows you to borrow money, using your home’s equity as collateral.

Wait. Don’t click to another page. If the above paragraph seems like gibberish, you have surfed to the right place. We will explain what home equity is, what collateral is, how these loans and lines of credit work, why people use them, and what pitfalls to avoid.

First, some definitions:

Collateral is property that you pledge as a guarantee that you will repay a debt. If you don’t repay the debt, the lender can take your collateral and sell it to get its money back. With a home equity loan or line of credit, you pledge your home as collateral. You can lose the home and be forced to move out if you don’t repay the debt.

Equity is the difference between how much the home is worth and how much you owe on the mortgage (or mortgages, if you have more than one on the property).

Example:

Let’s say you buy a house for $200,000. You make a down payment of $20,000 and borrow $180,000. The day you buy the house, your equity is the same as the down payment — $20,000: $200,000 (home’s purchase price) – $180,000 (amount owed) = $20,000 (equity).

 
Fast-forward five years. You have been making your monthly payments faithfully, and have paid down $13,000 of the mortgage debt, so you owe $167,000. During the same time, the value of the house has increased. Now it is worth $300,000. Your equity is $133,000: $300,000 (home’s current appraised value) – $167,000 (amount owed) = $133,000 (equity)

A home equity loan (or line of credit) is a second mortgage that lets you turn equity into cash, allowing you to spend it on home improvements, debt consolidation, college education or other expenses.

Equity loans, lines of credit defined …
There are two types of home equity debt: home equity loans and home equity lines of credit, also known as HELOCs. Both are sometimes referred to as second mortgages, because they are secured by your property, just like the original, or primary, mortgage.

Home equity loans and lines of credit usually are repaid in a shorter period than first mortgages. Most commonly, mortgages are set up to be repaid over 30 years. Equity loans and lines of credit often have a repayment period of 15 years, although it might be as short as five and as long as 30 years.

A home equity 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. Bankrate surveys home equity lenders and is a good source for current rates.

A home equity line of credit, or HELOC, works more like a credit card because it has a revolving balance. A HELOC allows you 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, you can use the credit again, like a credit card.

Example:

Let’s say you have a $10,000 line of credit. You borrow $5,000 to pay for new kitchen cabinets. At that point, you owe the $5,000 you borrowed, and you have $5,000 remaining in your credit line, meaning that you could borrow another $5,000.

Instead of borrowing more from the line of credit, you pay back $3,000. At this point, you still owe $2,000, and you have $8,000 in available credit.

A HELOC gives you more flexibility than a fixed-rate home equity loan. It also is possible to remain in debt with a home equity loan, paying only interest and not paying down principal.

A line of credit has a variable interest rate that fluctuates over the life of the loan. Payments vary depending on the interest rate, the amount owed and whether the credit line is in the draw period or the repayment period.

During the equity line’s draw period, you can borrow against it and the minimum monthly payments cover only the interest, although you can elect to pay principal.

During the repayment period, you can’t add new debt and must repay the balance over the remaining life of the loan.

The draw period often is five or 10 years, and the repayment period typically is 10 or 15 years. Those are generalizations, and each lender can set its own draw and repayment periods. Lenders have been known to have draw periods of nine years, six months, and repayment periods of 20 years. Bankrate surveys home equity line of credit lenders for their current rates.

A line of credit is accessed by check, credit card or electronic transfer ordered by phone. Lenders often require you to take an initial advance when you set up the loan, withdraw a minimum amount each time you dip into it and keep a minimum amount outstanding.

With either a home equity loan or a line of credit, you have to pay off the balance when you sell the house.

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