The money’s in the walls
I used to watch home makeover TV shows, the ones where the homeowner drops $50,000 on a new state-of-the-art kitchen with double ovens and an eight-burner range. While the “afters” were almost always exquisite, I would sit on my couch and yell things at the television. “Who has $50grand lying around for a new kitchen?”
I’d say, “And how often are people cooking eight things at once anyway?”
I stopped watching those shows, mostly because they made me crazy, but not before I learned a little bit about home equity loans. Turns out most folks don’t have $50,000 sitting in their bank accounts; it’s hidden in the walls of their house.
A look at loans
There are two types of home equity loans: A fixed-rate loan and a line of credit. They’re quite different, but they do have a few things in common. First, both allow you to borrow against the equity in your home. Both are available with terms that are typically 5 to 15 years. And both must be repaid in full if the home is sold (a very important point in this day and age, where sudden layoffs and unexpected moves seem to be more frequent).
A fixed-rate loan, sometimes called a second trust mortgage, provides a single, lump-sum payment to the borrower, which is repaid over a set period of time, usually 5 to15 years. With this type of loan, the interest rate and payment amount are locked in, so your payments won’t fluctuate over the life of the loan. It is, however, a monthly payment in addition to your regular mortgage, so if your finances are tight as it is, taking on an extra monthly bill is probably not the best thing to do.
However, the home equity loan can be a great option for longtime homeowners who have built some equity into their home and have a large but important expense on the horizon, said Charlie Crowe, vice president/home loan manager at Bank of America in Annapolis, Md. “Homeowners should use the home equity loan for what’s necessary, what you really need, like helping with college tuition or putting on a new roof,” Crowe said. “Be careful about using it for things that don’t have a lasting value, like a vacation.”
That mindset of having extra cash to blow is easy to fall into, particularly with the second type of loan, the home-equity line of credit. This is typically a variable-rate loan that works like a credit card, making a certain dollar limit available to you to spend at will. Borrowers can withdraw money when they need it using a special credit card or designated checks, and monthly payments vary based on the amount of money borrowed and the current interest rate.
Like fixed-rate loans, the line of credit has a set term (5 to 15 years), so when the end of that term is reached, the outstanding loan amount must be repaid in full.
Do the math
“You want to be an informed consumer and check around, because there are home equity lines of credit available on an interest-only basis,” Crowe said. “From a monthly payment standpoint the line of credit’s a little easier to make, but you have to make sure you have the wherewithal to pay that down.”
Lenders want to make sure you have the ability to pay off the loan too. They require a certain loan-to-value ratio in order to make the deal, Crowe said. They also will approve only those with a decent credit score and a proven ability to pay back the loan.
The second mortgage can be beneficial for tax purposes, financial planning and tackling important family expenses. But Crowe advises homeowners to make sure the pros far outweigh the cons. “Be very aware of your financing options, and make sure it’s for the right reason,” he said.
Robyn Passante is a freelance writer and mother of two who will never have an 8-burner range. She can be reached at email@example.com.