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When shopping for home equity financing, be aware that you can choose from three types of programs: a home equity line of credit, a home equity line of credit with the option to fix, and a home equity loan.
Each program is good for financing home repairs and improvements, but since each one operates a bit differently, it pays to choose the program that best suits your needs.
The most popular type of home equity financing product is a home equity line of credit (HELOC). A HELOC is a revolving line of credit with an interest rate tied to the prime interest rate. You get access to the money as you need it, up to a pre-set limit.
The HELOC looks and functions like a checking account. Use a HELOC to help avoid charging renovations or home improvements to a high-interest credit card or depleting your personal savings. As you draw on your line of credit, you pay interest only on the funds that you use. If you make more than your minimum payment, your principle will decline. As you do this, funds become available to use again.
A HELOC with the option to fix is a good product for people who worry that short-term interest rates will continue to rise. The "fix" part refers to the fact that you're allowed to fix the interest rate on the portion of the money actually in use, subject to certain constraints.
In contrast, the interest rate applicable to the outstanding balance on a traditional HELOC is variable. The rate for the fixed portion of a HELOC is determined by the three-year T-bill plus a margin. Hence, a HELOC with the option to fix can be a good financing tool in an uncertain economy.
A Home Equity Loan is a traditional loan with a fixed interest rate. The amount of money you can borrow depends on the equity built up in the value of your home. While the biggest advantage of a Home Equity Loan is its fixed interest rate for the entire life and amount of the loan, its biggest disadvantage is that you're required to borrow the entire amount of the loan all at once. This means that repayments of both principle and interest begin right away.
If you have a specific home improvement project in mind with a fixed cost, the Home Equity Loan can be a very economical way to go. But you'll also be tempted to use excess funds for other purposes, which can defeat other financial planning goals you might have down the road.
The bottom line, as always, is education. Be sure to speak to a mortgage professional before embarking on any kind of financing for your home improvement and repair projects to find out what the best program is for you and your financial goals.
Got questions about real estate financing? Contact Debbie@westchester-mortgage.com or 617-965-1236. She'll consider them for inclusion in a future column. Debbie Siegel is president of Westchester Mortgage in Newton, MA. She is licensed in several Northeastern states.
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