The Guide to Bank Loans
Home Equity Line of Credit
Best if: You own a home and want a pot of cash to dip into.
The benefits: This type of loan (a HELOC, for short) usually gives you access to a large sum of money, but you don’t have to take the whole lot all at once. “A HELOC is handy if you want to have backup funds available in case of an emergency―for example, if you’re a freelancer with a variable income,” says Manisha Thakor, a coauthor of Get Financially Naked ($13, amazon.com). The line is backed by your home and is open for 20 to 30 years, but typically you can borrow only during the first 10 years (the “draw period,” in banking lingo). Applications take up to 45 days to process, but once the line is open, you can use checks or a debit card to spend the money on anything you please and the bank typically bills you only for the interest. The rate, while variable, can be lower than other options. And the cherry on top? Uncle Sam gives you a tax deduction for interest paid on balances of up to $100,000.
Worth knowing: The good times don’t last forever. Once the draw period is over, you’re on the hook for both the interest and the principal―and that can nearly double your monthly payment. Additionally, interest rates could rise, so “before accessing your line of credit, calculate whether you can afford a higher monthly payment,” says Tracie Southerland, a financial adviser in Palo Alto, California. (Use the calculator at mortgagesum.com.) And take note: Many financial experts suggest that your HELOC plus your mortgage not add up to more than 60 to 80 percent of your home’s value. So if you live an area where home prices are continuing to fall, you could see your equity line reduced or even cut off.
Best if: You own a home and need to make a major purchase right now.
The benefits: Home-equity loans are similar to HELOCs but differ in two important aspects. First, you borrow a lump sum of money at one time. And second, you lock in a fixed interest rate for the entire length of the loan, usually 10 to 15 years. If you want to renovate your kitchen or need to pay for your kid’s braces, you’ll get all the cash at once and you’ll know exactly how much you owe for the entire duration of repayment. Interest on borrowed funds is tax-deductible in many cases, but it’s more favorable taxwise to use the money to make home improvements.
Worth knowing: If you pay off the balance early, be prepared to get hit with a potentially expensive prepayment penalty (either a flat fee or a percentage of the full loan amount). And gone are the days when banks would gladly fork over up to 80 percent of your home’s value. “To keep from overextending themselves, they might now offer only a loan of less than 50 percent of your home’s value or equity,” says Thakor.