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Home Equity Basics

Posted by  on Apr 16, 2009
 
Deciding which home equity loan is best for you depends on if you want to receive your money in one lump sum, as well as what you need to use the money for. Remember that there are three ways to turn your home equity into usable cash. One is cash-out refinance, which is when you take a cash-out refinance. This means you are refinancing your existing loan to a larger amount than what you owe and taking the difference in cash. You receive your money in a lump sum and you might use the cash for home improvements or debt consolidation. If the mortgage interest rate on your existing home loan is higher than current rates, it may make sense to refinance this way.

If you have a great mortgage interest rate and do not want to refinance your existing mortgage, a home equity loan might be the way to go. A home equity loan is a second loan that you take out in addition to your first mortgage. It allows you to get cash from your home's equity.

A home equity loan takes less time than refinancing your first mortgage and is a good choice if you would like your cash in a lump sum. Again, you might use this for home improvements or paying off high-interest credit card debt. You might also use it to pay medical bills or finance a second home.

A home equity line of credit is different from the first two options. It works similar to a checking account or credit card except that it uses the equity in your home as the revolving line of credit. You pay only when you use the money. However, unlike credit cards, the interest is usually tax-deductible.

With a home equity line of credit, you have the choice of getting a lump sum at closing or only part of your money and drawing on the rest when you need it. Unlike a home equity loan or a refinance, you can get a home equity line of credit in as little as ten days. A home equity line of credit can be a good choice if you need to access your money more than once, like when you are renovating your house and need to pay different contractors at separate times.

Most lines of credit are tied to the prime rate, which goes up and down in lockstep with the Federal Reserve's short-term rate- ratcheting. In addition, those rates have been going up steadily since June 2004. It does not make sense to lock in a higher rate so that you will not have to worry about higher rates there are other disadvantages. With a fixed-rate loan, you lose the flexibility to pay only the interest; you will have to tackle larger payments designed to retire the loan in five to 15 years. In addition, you may have to pay closing costs. Some lenders charge a penalty for closing a line of credit within the first three years of establishing the line.

Lock in part of your loan. Many lenders have dusted off this option, introduced before the last refinancing boom. You can convert all or part of your outstanding balance to a fixed rate, once, and sometimes multiple times, often at no cost. The variable rate would still apply to future draws, preserving your ability to make lower, interest, only payments on the new amounts.

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