Home Equity Loans
A home equity loan is a mortgage which is taken out by an existing home owner in order to use the funds for one or more of a number of purposes. Those purposes can be related or otherwise to the property itself, such as to fund home improvements, a new car, a world cruise, a college education or to repay credit card debt. A home equity loan can be taken either as a first mortgage or a second mortgage, each of which can be in the form of:
- A fixed rate mortgage (FRM); or
- An adjustable rate mortgage (ARM).
In the case of the latter, the mortgage can take the special form of a line of credit. Home equity loans are often described as a means of 'releasing' equity from one's home.
Home Equity Line of Credit (HELOC)
A home equity line of credit is a loan which is secured by way of mortgage, and which can be drawn upon either in one amount or several up to a specified maximum. HELOCs also have a specified period in which the funds must be drawn, followed by a period in which the loan must be repaid. While the mortgage is in the draw period, borrowers are only obliged to pay interest on the accrued loan balance.
A HELOC is an adjustable rate mortgage, but it differs from a conventional ARM in at least three important respects:
- Interest on the mortgage is calculated daily, not monthly;
- The mortgage has no rate adjustment cap; and
- The mortgage has a much higher maximum rate (equal to 18% per annum in all but one state).
The principal advantages of a HELOC include ease of implementation, interest applying only to funds drawn as required, and low payments (interest only) during the draw period. The major disadvantage of a HELOC is the exposure of the borrower to interest rate increases, which can over a period of time be substantial.