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Home equity loans as a concept have been very popular with borrowers because
they allow them the dual benefit of lower interest rates than first mortgages
and tax deductions. However, a home equity loan must be undertaken after
carefully understanding the circumstances for which it is needed.
There are two broad types of home equity loans:
Term loans:
Home equity loans of a fixed nature are also called second mortgages. For
example, if you have bought a home for $10,000, and made a down payment of
$1,000, and taken a mortgage for the rest and have managed to repay another
$2,000, then you can apply for a home equity loan of $3,000. Term loans have a
normally shorter tenor than first mortgages. Tax deductions can be claimed on
interest repayments. It is a normal loan wherein you repay the loan in fixed
installments over a period of time.
Lines of credit:
A home equity line of credit loan is like a normal credit card wherein you have
a line of credit extended to you and you can keep borrowing against it. To
borrow from the earlier example, the line of credit that is available to you is
$3,000. However, if you have borrowed only $1,500 and then repaid back $1,000,
then the line of credit available to you is $2,500.
The difference between a line of credit and a term loan is that the interest
rate is linked to the prime-lending rate of banks, due to which the payments may
fluctuate over the period. Moreover, most lenders only advance a line of credit
for 90% of the home equity. However, when the period of a line of credit
expires, all outstanding dues must have been cleared.
Borrowers are often confused as to the nature of the home loan that needs to be
undertaken. If the nature of the work is a one-off thing like remodeling the
house, then a term loan can be taken. If it is a recurring necessity, such as
putting a child through college, then a home equity line of credit becomes
attractive. |
