The term of a lump-sum home equity loan usually runs 10 to 15 years. In this type of loan, you borrow the entire amount at closing and repay it over the term. Another type of equity loan is a home equity line of credit, or HELOC. With a HELOC, you can borrow against a credit limit multiple times during a period of 5 to 10 years, called the draw period. The requirements for repaying a HELOC vary, but some lenders give you as long as 20 years after the draw period.
Both lump-sum equity loans and HELOCs are secured by the value of your home. Banks usually limit the amount you can borrow to between 80 and 90 percent of your home equity, according to Bankrate.
For loans up to $100,000, the interest for either type of home equity loan usually is deductible on your federal income taxes.
Characteristics of Lump-Sum Equity Loans
A lump-sum equity loan may suit your needs if you need cash all at once -- for example, to start small business. It's also called a closed-end loan, term loan or second mortgage.
A term loan is much like a first mortgage, because it usually has a fixed rate of interest, and you begin paying the balance back immediately. Your monthly payments stay the same over the life of the loan and go toward both principal and interest.
The fixed interest rate of a second mortgage usually is higher than the initial rate on a HELOC, because you're protected from future rate increases.
Characteristics of HELOCs
A HELOC is a suitable choice if you don't want to pay interest on money before you actually need it. For example, you could use the money each year to pay college tuition, drawing only as much as you need to settle the bill. However, some lenders require a minimum withdrawal when you complete the loan, and some have a minimum amount for subsequent withdrawals.
A HELOC usually has an adjustable interest rate, although some lenders offer a fixed-rate option. With an adjustable rate, you assume the risk of rising rates.
Some HELOCs require paying an annual maintenance fee of $15 to $75. If you want to opt out early, some lenders charge cancellation fees.
Paying Back a HELOC
The conditions for paying back a HELOC vary. Many lenders allow you the option of paying only the accrued interest each month during the initial draw period, giving you smaller payments. Even with interest-only, your payments can fluctuate depending on how how much you've borrowed to date and changes in interest rates. If you borrow additional sums and interest rates also increase, your minimum payment may go up significantly.
If you start repaying principal during the draw period of a HELOC, the credit revolves, similar to that of a credit card. For example, you may have a $5,000 credit line and borrow $1,000. Your available credit returns to $5,000 when you repay the $1,000. After the draw period, you typically have between 10 and 20 years to pay back the principal.
The start of the payback period can cause a shock to your budget. Including principal and interest, it's possible for your monthly payment to double.