Understanding Home Equity Loans and Lines of Credit

Are you looking to make a much needed repair to your home or pay off your credit card balance? If you're in this predicament, then you may want to think about borrowing against your home's equity. Owning your home for a few years can help you build up equity, which can then be turned into a line of credit or loan to assist you in paying for things such as education expenses or home repairs.

But before you meet with a lender to put your home up for collateral, you should do a little bit of research. If this is your first time dealing with equity, you want to know all the rules to avoid hurting your credit score. Knowing about home equity loans and credit lines can educate you about your decision. Both of these are different from each other, and knowing the difference can guide you in determining which one you are going to take out.

Home Equity Loan
This is similar to your mortgage, where you make monthly payments to the loan amount you have decided to take out. You are only allowed up to 85 percent of your equity for a loan, and lenders will inspect your income, credit score and value of your home before determining the amount of the loan. With a home equity loan, your interest rate will be fixed for the duration of the loan, and payments are due monthly, so you can factor these into your budget. Plus, you can use a home equity loan to pay off your credit card debt, which can assist in dropping your credit-utilization ratio.

Home Equity Line of Credit
A HELOC resembles a standard line of credit where you can pay for things using a credit card and pay back whatever you took out. The amount you borrow is determined by a certain percentage of your property's value, which is then subtracted from your mortgage. But in this situation, along with home equity loans, your home will be used as collateral, so continue to make your payments on time.

Like a home equity loan, lenders will take into account your credit, employment and debt history. A HELOC can be a good option because you don't have to take out the entire amount at once as a lump sum; rates are generally lower than for consumer credit cards; and you can use a HELOC in times of emergency, such as if you lose your job or need to repair your home after it has been damaged.

Bad practices
Both of these home equity borrowing choices can be viable options if you have a good credit score and have built up enough equity, but if you use these new lines of debt improperly, you could lose your home and the equity you have saved up. The Federal Trade Commission says there are a few harmful practices to avoid when using equity:

  • Flipping a loan: Continually refinancing a loan to get more money.
  • Bait and switch: A lender tries to change the loan terms after agreeing on the first set of terms.
  • Growing insurance: Lenders add insurance that you don't need.