Differences Between Home Equity Loans
- There are two types of home equity loans.the cost of housing image by Pix by Marti from Fotolia.com
A home equity loan is a loan that uses the borrower's home as collateral. The equity in the home is determined by the current value of the home less any outstanding debts on the home. For example, if the home is worth $500,000 and the borrower has a $300,000 mortgage balance, there is $200,000 of equity in the home. This $200,000 is used as collateral for the home equity loan. Home equity loans can be used for anything from consolidating debt, home improvement, purchasing a car or education. There are two basic types of home equity loans, a term loan and a home equity line of credit. - Term loans and lines of credit often differ in when and how the money is distributed. A term loan allows the borrower to receive the full loan amount up front and pay the loan off over a set period of time. At the end of the loan the entire principal amount has been paid off.
In a home equity line of credit, the homeowner may request a specific loan amount based on the equity of the house. The homeowner may borrow any amount at any time, up to the loan amount. Many home equity lines of credit require the homeowners take out an initial amount, make withdrawals of a specified amount and frequency, or keep a minimum amount outstanding on the line. The payment is based on the outstanding balance, not the maximum loan amount. If the borrower has only paid interest and little principal by the end of the term, the borrower will have a big balloon payment. Every few years the bank can pull the borrower's credit history to determine whether to keep the line open. - The type of interest rate you receive with a home equity loan often depends on the type of home loan you receive. The interest rate and monthly payments for a term loan are fixed. Therefore, the borrower knows the set amount of the monthly payment, which stays the same throughout the life of the loan. Generally, interest paid on a term loan is tax deductible.
The interest rate for a line of credit, however, is usually a variable rate and is subject to the rate going up or down, which can change drastically, resulting in the loan becoming more expensive. Generally, interest paid on a line of credit also is tax deductible. - With a home equity term loan, the borrower is often required to pay closing costs. A home equity line of credit normally does not require any closing costs.
There can be differences between annual percentage rates for home equity loans too. When comparing the annual percentage rate as a measure of cost between a home equity term loan and a home equity line of credit, the borrower should be aware that the annual percentage rate for a term loan takes points and financing charges into consideration while the annual percentage rate for a home equity line of credit does not. In either case, it is important to remember that home equity loans are secured by the borrower's house. If the borrower defaults on the loan the home could go into foreclosure.
