Equity Line of Credit: the Answer to Your Financial Needs?

What's sometimes better than money in the bank? Home equity!

Simply put, home equity is the current value of your home, minus the balance you owe on your mortgage.

While typical bank savings accounts may earn an average 2% annual return, home values have been appreciating at 10-20% or more -- sometimes much more -- per year.

Thus, as a homeowner, you have a potentially very powerful financial resource at your fingertips.

One of the most popular ways to tap into that resource is a home equity line of credit.

Is a Home Equity Line of Credit Right for You?

A home equity line of credit works something like a credit card.

Once your maximum loan amount is determined by a lender, you can borrow any amount up to that maximum. And like a credit card, your loan payments vary based on the amount you have used. As you pay down the balance, your payments go down... and your available loan balance goes back up.

Say for example you have a home that would sell for $300,000, and your mortgage balance is $200,000. Your equity is the difference, or $100,000. Most lenders will loan 100% of the equity (depending on your credit rating and some other factors). So your maximum loan amount would probably be set at $100,000. That's your "credit limit."

If you use $50,000 to remodel your home, you make payments based on that $50,000 -- not the $100,000 maximum loan amount. If you borrow an additional $20,000 to put in a swimming pool before paying down the existing $50,000 balance, your payments would be based on the new amount, $70,000. And you still have access to the remaining $30,000. As your loan amount varies, so does your monthly payment.

This is different than a typical loan in which you would borrow a lump-sum amount and make fixed monthly payments based until the entire loan is repaid.

More Flexibility

A home equity line of credit gives you more flexibility than a typical loan. You only use (and pay for) the amount of money you really need, as you need it. And you won't need to re-apply for a new loan every time a new financial need comes up.

Speaking of financial needs, here are some of the most popular reasons for obtaining an a home equity line of credit.

  • Consolidate Debts. Using your equity line of credit to consolidate other debts may eliminate the stress of multiple bills plus give you a more favorable interest rate, with a lower monthly payment -- and possibility even tax benefits!

  • Make Home Improvements. Many people use an equity line of credit for renovating, remodeling, or improving their home. Certain types of improvements, such as kitchen renovations, can increase the value of the home as well as make the occupants happier!

  • Refinance Existing Mortgage. Have interest rates decreased since you bought your home? If so, you might consider using a lower-rate equity line of credit to pay off the existing, higher-rate mortgage. Note, however, that while a line of credit may take advantage of current low interest rates, you may find that your regular loan protects you better from fluctuating rates. So if you will not be paying off the loan within the next few years, it may be best to keep your existing loan with it's fixed interest rate.

    When Should You NOT Use a Line of Credit?

    Before succumbing to what seems like 'easy money,' it is important to evaluate the additional risk.

    Some debts -- such as student loans -- have features that you may not be entitled to if you switch them to an equity line of credit.

    Other expenses, like a new car, may seem like good items to buy with your home equity line of credit, but weigh the pros and cons carefully. Some home equity line of credit loans allow you to pay only the interest for many years. Would you really want to be paying for a car for several years after it's lost most of its value? Unless you plan to pay off the debt as quickly as possible (which typically would mean paying more than the minimum payment), using a home equity line of credit for "disposable" consumer goods is probably not the best choice.

    Remember, before taking on any financial obligations, it is important to understand the risks as well as the benefits. A home equity line of credit can be the appropriate answer to your financial needs, but be sure to get as much information as possible before signing on the dotted line.

    For more information about home equity loans and lines of credit, visit http://www.EquityLoanFacts.com