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A home equity line
is a form of revolving credit in which your home serves as
collateral. Because the home is likely to be a consumer's
largest asset, many homeowners use their credit lines only
for major items such as education, home improvements, or medical
bills and not for day-to-day expenses.
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.
Many lenders set the credit limit on a home
equity line by taking a percentage (say, 75 percent) of the
appraised value of the home and subtracting the balance owed
on the existing mortgage. For example: |
| Appraisal of home |
$100,000 |
| Percentage |
x75% |
| Percentage of appraised value |
$75,000 |
| Less mortgage debt |
-$40,000 |
| Potential credit line |
$35,000 |
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| In determining your actual
credit line, the lender also will consider your ability to repay,
by looking at your income, debts, and other financial obligations,
as well as your credit history. Home
equity plans often set a fixed time during which you can borrow
money, such as 10 years. When this period is up, the plan
may allow you to renew the credit line. But in a plan that
does not allow renewals, you will not be able to borrow additional
money once the time has expired. Some plans may call for payment
in full of any outstanding balance. Others may permit you
to repay over a fixed time, for example 10 years.
Once approved for the home equity plan, usually
you will be able to borrow up to your credit limit whenever
you want. Typically, you will be able to draw on your line
by using special checks.
Under some plans, borrowers can use a credit
card or other means to borrow money and make purchases using
the line. However, there may be limitations on how you use
the line. Some plans may require you to borrow a minimum amount
each time you draw on the line (for example, $300) and to
keep a minimum amount outstanding. Some lenders also may require
that you take an initial advance when you first set up the
line.
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Costs to Obtain
a Home Equity 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. For example:
- 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.
Comparing a line of credit and a traditional
second mortgage loan
If you are thinking about a home
equity line of credit you also might want to consider a more
traditional second mortgage loan. This type of loan provides
you with a fixed amount of money repayable over a fixed period.
Usually the payment schedule calls for equal payments that will
pay off the entire loan within that time. You might consider
a traditional second mortgage loan instead of a home equity
line if, for example, you need a set amount for a specific purpose,
such as an addition to your home. In
deciding which type of loan best suits your needs, consider
the costs under the two alternatives. Look at the APR and
other charges. You cannot, however, simply compare the APR
for a traditional mortgage loan with the APR for a home equity
line because the APRs are figured differently.
- The APR for a traditional mortgage takes
into account the interest rate charged plus points and other
finance charges.
- The APR for a home equity line is based
on the periodic interest rate alone. It does not include
points or other charges.
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