Using Your Home Equity
A home equity line of credit can be your financial safety line in tough times.
You know the mantra: Experts say you should have three to six months worth of living expenses set aside in a safe, easy-to-access account, such as a money market. Indeed, cash on hand beats borrowing any day, so if you haven't already built an emergency fund, commit to doing so now.
As you evaluate your financial safety net, don't overlook your home's equity. A home equity line of credit is a great backup if you have an extended layoff or steep unexpected expenses, like medical bills.
A home equity line of credit is a flexible way to borrow against the equity in your home. Once you open up a home equity line with your lender (in a process similar to applying for a mortgage, only less involved), you can borrow from it (up to a set amount) when you decide you need to, and you'll only pay interest on the money you borrow. As long as you don't borrow anything, you won't owe any interest.
Most home equity lines come with variable interest rates, though a few offer fixed rates. And these days, lenders offer many ways for you to conveniently tap your available credit, most often by writing checks or using credit cards linked to the line of credit.
Do not confuse a line of credit with a home equity loan. With a home equity loan, by comparison, your lender doles out a lump sum and you're typically charged a fixed interest rate; you then repay the loan in fixed monthly installments. Home equity loans are best reserved for those times when you need a set amount of cash, for example, to complete a home improvement, start a business, or consolidate high-interest debt.
By contrast, a home-equity line of credit is more like a safety net: there if you need it, but not in your way when not in use.
Generally, the money you borrow against your home, either through a home equity loan or line of credit, is tax-deductible. The IRS lets you write off up to $100,000 in interest you pay on these loans (or up to $1 million if you use the money to fix up your home).
Their tax deductibility and their decent interest rates (as of late 2002, 4.46 percent on average for a $10,000 home equity line of credit; 4.15 percent for a larger, $30,000 credit line) make home equity lines of credit worth considering over many other types of personal loans (which are not deductible). And they're a clear winner over credit cards which have average rates ranging from 13.42 percent to 15.44 percent, according to Bankrate.com.
Know Your Rights
If you're afraid you might lose your job in the near future, start shopping around for a home equity loan with good terms now, while you can qualify.
As when shopping for a mortgage, you should compare the offerings of several lenders before settling on any deal. Make sure you understand all of the terms and conditions. In addition to comparing interest rates and monthly payments, make sure you compare any fees (which may show up in the form of points, origination fees, or other types of closing costs). Some lenders even charge annual fees to keep the line of credit open.
Also, be sure you understand how money you borrow gets paid back -- some home equity lines require a huge balloon payment when the loan's term ends, others let you pay off any outstanding balance over a fixed number of years.
Once you sign on the dotted line, you still have three days to back out of the deal. If you change your mind, you must notify the lender in writing, and the lender must return any money you've handed over so far.
Using the Money Wisely
Just because you have easy access to a huge pot of credit doesn't mean you should tap it freely. Take care to use your line of credit responsibly; for example, to help cover your expenses if you exhaust your emergency fund during an extended layoff. Resist the urge to tap it for more frivolous reasons, like to pay for a trip to Europe or to buy the entertainment center you've always dreamed of.
Remember, any money you borrow is backed by your home. If you run up big expenses that you're unable to pay back on time, you put your house in jeopardy.
And know this: Your stream of credit may not last forever. Many lenders check your credit annually; while your lender cannot accelerate the loan payments or change the terms, it can suspend or reduce your borrowing privileges.
Lastly, with so many lenders competing to offer home equity lines and loans these days, you need to be on your guard. The Federal Trade Commission warns consumers that there are a number of abusive tactics out there, including hiding loan terms and coercing homeowners to accept home equity loans they can't reasonably afford. For more on the warnings visit the FTC's Web site.