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equity lines of credit



Line of Credit Loan

Rising interest rate on line of credit:

Both home equity loan and home equity line of credit are efficient tools to organize your debt and the most attractive part is that the interest is usually tax-deductible. Home equity loan and home equity line of credit are similar to your original or first mortgage in the sense that they are also secured by your property. But home equity loan and line of credit are for a shorter time period than the first mortgage. It is common for your original mortgage to run for 30 years while a line of credit will have a much shorter time horizon, maybe five years.

But there is a basic difference between a home equity loan and a home equity line of credit which must be properly understood before discussing the impact of increased line of credit interest rate.

Home Equity Loan this is just like any other secured term loan. You get a one time lump-sum based on the value in your home and then you are supposed to pay off this amount over a pre-decided time period with the interest rate always remaining fixed. Thus, you are making the same payment each month. Once you have taken the loan amount, you cannot borrow any further from the loan.

Home Equity Line of Credit (HELOC)HELOC is more or less similar to a credit card. You can borrow up to a certain amount during the life of the loan-which happens to be a time limit which the lender ha set. During this time, you can withdraw as much money as you need (within the maximum limit constraint), as many times as you like. And as you are paying off the principal, your credit keeps revolving and thus you can use it again and again.

An illustration will make the preceding discussion crystal clear. Say you have a $15000 line of credit. You took out $5000 from it but soon after that, paid back $2000 towards the principal. So now the credit available to you is $12000. And thus, a line of credit is giving you more flexibility compared to a fixed-rate home equity loan.

Important features of a line of credit loan:

Credit line loan charge variable interest rate. So as the interest rate keep fluctuating over the life of the loan, you payments will also keep varying depending upon the current interest rate charged and the amount of credit you have used. When the life of a credit line expires, lender may or may not offer a renewal. In case there is no renewal, you must pay off everything.

To access a line of credit, lender gives you either especially issued checks or a credit card. Credit card debt consolidation is the most popular reason for people deciding to dig into their home equity. Consumers whose credit card debt is slipping out of their control often take such a loan and pay off the credit card company. Then they keep paying back the bank over an extended period of time at interest rate which happens to be much lower as compared to the rate charged by the credit card company.

An important decision requiring careful consideration:

Putting your home equity on the line is not a decision which can be taken lightly or rushed into. Is it really a smart move to put your most prized possession, your home, on the line, to pay off your credit card debt which you could have easily kept within manageable limits with just a little foresight, financial prudence and self-discipline.

And this brings us to the single most important question that every consumer thinking of taking a HELOC must ask himself/herself are you absolutely sure that a credit line, which can be used more or less like a credit card, wont tempt you into using the available credit carelessly.

Remember, if you run a credit card debt, no one will come to take away your home, but if you used your credit line carelessly and then, somehow failed to pay back, you will be facing the horror of losing your home!!

The increase in interest rate of HELOC in the last two years.

Yes, the interest rate on HELOC has doubled in the last two years and this is an even more dramatic rise than the rise in gasoline prices. So, if you have a HELOC, what are your options.

Let us discuss the options one by one:

• You can keep your credit line and try to pay off the balance quickly. Remember, HELOC gives you added flexibility in terms of cash flow, which is completely missing from other term loan options such as a home equity loan. But since the interest rate of HELOC has really jumped up, it makes sense to try paying down the balance on the credit line quickly. Here, the question is do you have the financial discipline and the income to pay down the balance on your line of credit if you cant confidently say yes to this question, you will have to explore other options.

• A lot of people have decided to simply do nothing about their credit line. While in some cases, this is a well thought-of decision, in other cases, people just dont want to go through the trouble of making a change. These people will just let their credit lines as it is and will grin and bear the increased rates. The logic behind this decision is that most people believe that Federal Reserve has almost finished raising interest rates and so the pain cant get much worse now.

• In a line of credit, the borrower is paying only the interest for a few years (interest on the outstanding balance that is). The interest rates of line of credit go up and down following the prime rate and the prime rate responds to the rate moves of the Federal Reserve. Since January 30, 2004, the prime rate has moved up 17 times! That is why this increase in the line of credit interest rate. If you change your line of credit into a fixed-rate home equity loan, you will lose flexibility but can get a much lower interest rate. Only point in paying off your line of credit with a fixed-rate, closed-end home equity loan is that it requires you to pay the principal right from the very beginning and not everyone maybe ready for this rigor.

• Then there is the option of cash-out refinance of your primary mortgage to pay off your line of credit. But even a cash-out refi option is no longer as popular as it was last year because of the upward movement of the mortgage rates, and therefore, it is natural that homeowners will not like to refinance their mortgage at a higher rate. Plus, a cash-out refi means paying thousands of dollars as fees whereas line of credit has much lower fees.

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