A home equity loan typically provides a one-time loan payment to the borrower.
Normally there is a fixed payment term (such as 5 to 10 years) and a fixed dollar monthly payment.
When the loan is paid off, the borrower can apply again (and pay loan set-up fees again) for another home equity loan.
For example, a retiree may obtain a home equity loan of $20,000. With a loan term of 7 years and an 8 percent annual interest rate, monthly payments would be approximately $312.
A home equity line of credit provides a retiree with a set amount of cash that can be borrowed all at once or over time as needed. The interest rate is usually variable, meaning your costs can rise or fall over time. Once the retiree borrows against the line of credit, payments begin at a rate determined by the loan documents.
For instance, assume a retiree qualifies for a $15,000 home equity line of credit. The retiree takes a $5,000 draw in the first month. Payments begin based on the $5,000 draw. A few months later, the retiree could draw an additional $3,000. Payments would then be based on roughly $8,000 of the loan. At some point in the future, the retiree could borrow the remaining balance of the line. Or, if the retiree eventually pays down the $8,000 loan, he or she would have up to $15,000 available again to borrow when needed.
Some home equity loans combine the features of a home equity loan and a home equity line of credit. A borrower can draw down a portion of the line of credit, but then lock that amount in to treat it as a home equity loan for a fixed period of time. The remainder of the line of credit remains available for future borrowing on a revolving basis.
Compared to a reverse mortgage, a home equity loan/line of credit is a less-expensive choice in terms of up-front costs (points, closing fees, etc.). On the downside, lenders will make these loans based on your income level and credit score. If you are living on a fixed income, qualifying for a loan may be problematic. Loan limits are also likely to be lower than they would be with a reverse mortgage.
This material is provided by MyRetirementPaycheck.org, a site from the National Endowment for Financial Education that helps people explore all of their retirement decisions.
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© 2012 National Endowment for Financial Education. Used with permission. All rights reserved.