Home Equity Credit Help
With their low interest rates, tax-deductible interest payments and long repayment terms, home equity credit can be appealing to many people. Homeowners who are considering using home equity credit should understand how the credit works before entering into an agreement. Although home equity loans and lines of credit have their advantages, using them can be a dangerous financial choice.
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How Credit Works
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Home equity credit allows homeowners to borrow money that is backed by the equity they have built in their homes. This means that the lender holds a share in the home as collateral against the debt. Home equity lines of credit have variable interest rates and work in a manner similar to credit cards, with borrowers writing checks from the line of credit, up to a maximum credit limit. Payments are often interest-only for a time, before switching to interest and principal. Home equity loans have fixed interest rates on a lump sum of money that is repaid with equal monthly payments over a set time period.
Amount to Borrow
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Lenders typically allow the sum of the remaining mortgage principal and the home equity borrowing to be no more than 80 percent of the home value. Multiply the market value by 0.8 and subtract the mortgage principal to find the maximum borrowing amount. Homeowners who know exactly how much money they need for a one-time remodeling project or to consolidate other debts should get a home equity loan for that amount. People with longer-term needs would be better off with a home equity line of credit.
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Negative Consequences
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Using home equity credit can have some negative consequences for the borrower. If the borrower is unable to make payments on the home equity debt, the lender can foreclose on the home and use the proceeds to repay the debt. In addition, if the value of the home drops, the homeowner could end up owing more on the home than it is worth. This makes it very difficult to refinance the mortgage or the home equity credit.
Precautions
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Tapping into home equity is not a decision to be made lightly. One of the major advantages of owning a home is building equity in the home and eventually living in it without having to make a payment at all. Before signing an agreement to use home equity credit, a homeowner needs to consider whether the decision is financially advantageous. In addition, the Truth in Lending Act allows borrowers three days after opening a home equity line of credit or home equity loan to change their minds and cancel the agreement, with all fees refunded.
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