Borrowing Against Your Home
When faced with a significant expense, such as medical costs, a new addition to your house, or a child's college education, you may find that you don't have the necessary cash on hand. In such a situation, you may want to consider a home equity loan or line of credit.
By using the equity in your home, you may qualify for a sizable amount of credit, available for use when and how you please, at an interest rate that is relatively low. Furthermore, under the tax law -- depending on your specific situation -- you may be allowed to deduct the interest because the debt is secured by your home.
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A Home Equity Credit Line
One way to borrow against the value of your home is a home equity line of credit, which is a form of revolving credit in which your home serves as collateral. With a home equity line, you will be approved for a specific amount of credit -- your credit limit -- meaning the maximum amount you can borrow at any one time while you have the plan.
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Costs of a Home Equity Credit Line
Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home. These costs include:
- A fee for a property appraisal, which estimates the value of your home.
- An application fee, which may not be refundable if you are turned down for credit.
- Up-front charges, such as one or more points (one point equals one percent of the credit limit).
- Other closing costs, which include fees for attorneys, title search, mortgage preparation and filing, property and title insurance, as well as taxes.
- Certain fees during the plan. For example, some plans impose yearly membership or maintenance fees.
- You also may be charged a transaction fee every time you draw on the credit line.
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All About Reverse Mortgages
A reverse mortgage allows you to convert the equity in your home into a lump-sum payment, monthly income, or a line of credit.
Why would you want to do that? Well, it can be a useful strategy in retirement (you must be at least 62 years of age to qualify for such a mortgage) if you want some extra income. It's called "reverse" because it reverses the direction of the payments: instead of building up equity in your house by putting the money in, you actually reduce equity in the house by taking money out.
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Another Option: Home Equity Loans
If you are thinking about a home equity line of credit, you also might want to consider a more traditional loan: the home equity loan. Also known as a second mortgage loan, this product is built around the fact that you have already paid for some portion of your home, and can now borrow against that equity.
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Repaying Your Home Equity Credit Line
Before entering into a plan, consider how you will pay back any money you borrow. Some plans set minimum payments that cover a portion of the principal (the amount you borrow) plus accrued interest. But unlike the typical installment loan, the portion that goes toward principal may not be enough to repay the debt by the end of the term. Other plans may allow payments of interest alone during the life of the plan, which means that you pay nothing toward the principal. If you borrow $10,000, you will owe that entire sum when the plan ends.
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Interest Rates on a Home Equity Credit Line
Home equity plans typically involve variable interest rates rather than fixed ones. A variable rate must be based on a publicly available index, such as the prime rate published in some major daily newspapers, or a U.S. Treasury Bill rate. The interest rate will change, mirroring fluctuations in the index.
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Equity loans: More popular, but more confusing
Mortgage bankers eagerly want to make 2004 the year of the home equity loan. First they have to clear up some misconceptions.
Many homeowners don't understand what an equity loan is. Lenders worry that consumers believe equity loans have high closing costs and are a hassle to apply for. And bankers think that a lot of potential borrowers don't know the differences between home equity loans and equity lines of credit.
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