Home Equity Frequently Asked Questions
As a homeowner, you can capitalize on the equity you've built in your home with a home equity loan or home equity line of credit. It could be one of the smartest, simplest ways to get the money you need to do the things you want. Here are some things you should know before you sign on the dotted line.
How does home equity work?
Home equity is created when the value of your home increases and/or when you reduce the amount you owe on your home through your loan payments.
If your home does not increase in value and you make interest-only payments, you are not building equity. This may make it harder to refinance your mortgage, or to receive funds from the sale of your home. In fact, if the amount you owe on your home, along with the costs associated with selling it (such as the real estate sales commissions and closing costs) exceeds the sale price, you will not receive any cash when you sell, and will have to pay additional funds to your lender or to other parties when you pay off your mortgage.
What is the difference between a home equity loan and a home equity line of credit?
It can be confusing, since both the home equity loan and the home equity line of credit use your home as collateral. Plus, both are sometimes referred to as a second mortgage, because they are secured by your property, just like your original (first) mortgage.
A home equity loan, sometimes called a term loan, supplies you with a fixed amount of money, payable over a fixed time period, typically with a fixed interest rate. You make the same payments each month. Once you receive the money, you cannot obtain additional money from the loan.
A home equity line of credit (HELOC) works differently. You are allowed to borrow funds up to your credit limit at any time during a time frame, called the draw period. If the principal is paid during the draw period, the money automatically becomes available for you to use again. You don't have to spend all the money either; you can withdraw money as it's needed. In most cases, credit lines have a variable interest rate that fluctuates over the life of the line. Some banks, including TD Banknorth, are now offering a fixed rate option on some lines of credit.
What can a home equity loan or line of credit be used for?
A home equity loan or line of credit can be used for anything you want. It can be used to consolidate your debt, for education or medical expenses, home improvements or any big-ticket purchase. The choice is up to you. Lenders may ask you why you want a home equity loan or line.
What are the features of interest-only payments?
The interest-only feature allows you to pay only the interest on the money you borrow for a specified period of time.
- Interest-only payments are lower than principal and interest payments.
- Interest-only payments provide flexibility for you to decide how much principal to pay down during the draw period.
If you only pay the interest that is due each month, when the interest-only period ends:
- You will still owe the amount you have drawn from your line of credit.
- Your monthly payment will increase – even if interest rates stay the same – because you must pay back the principal as well as the interest.
Why should I consider a loan or line of credit over a credit card?
In most cases, a home equity loan or line of credit will carry a lower interest rate than your credit card, and it may provide you with more money to do the things you need to do. As a further incentive, the interest paid on some loans or lines of credit can be tax deductible, just like with a first mortgage. Be sure to check with your tax advisor regarding the deductibility of interest.
What are some things I should know before I apply?
If you decide to apply for a home equity loan or line of credit, look for the plan that best meets your needs. Comparison shop to make sure your loan offer is reasonable. Examine the terms and conditions of various plans, including the annual percentage rate (APR) and other fees and charges. Don't simply compare the APR of a home equity loan to that of a home equity line of credit, because the APR of a loan takes into account the interest rate and all fees paid, whereas the APR for a line of credit takes into account only the interest rate.
If you decide you no longer want the loan after signing the loan papers, federal law gives you three business days after signing to cancel the contract, and the lender is required to return any fees or charges you had paid - only if the loan is secured by your primary residence and is not used to purchase the property.
Is there anything else I need to know?
Make sure you read and understand the loan documents, including the fine print. The Truth-in-Lending Act requires lenders to disclose all the terms and costs of every loan plan. Before you sign, make certain that the terms are the same ones you agreed to. For more information about the Truth-in-Lending Act, visit www.federalreserve.gov.
Taking out a home equity loan or line of credit is an important decision. Before entering into a plan, consider how you will pay back the money you borrow. Remember that your failure to repay the amounts you've borrowed, plus interest, could mean the loss of your home. Make sure you find a reputable lender who meets your needs and do your research so you know what to expect. If you are properly prepared, you should be able to sign on the dotted line with peace of mind.
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