If you’re thinking about making a home improvement or looking at ways to pay for your child’s college education, you may be thinking about tapping into your home's equity as a way to cover the costs. This is the difference between what your home could sell for and what you owe on the mortgage. Home equity financing can be set up as a loan or a line of credit.
Learn more about these types of loans and what you need to know in order to shop for the best deal.
Home Equity Financing
Before applying for home equity financing, consider how much money you actually need and how it will be used. Factor in the interest rate, any fees and the monthly payment.
Types of Home Equity Debt
Equity is the current value of your property, minus the amount of any existing mortgage on your property. Home equity financing allows you to borrow using the equity in your home as collateral. There are two types of home equity financing, home equity loans and home equity lines of credit. This type of financing is often referred to as a “second mortgage.”
Chart courtesy of Nerdwallet.com (https://www.nerdwallet.com/blog/mortgages/home-equity-loan-line-credit-pros-cons/ (opens new window) (You will be leaving NCUA.gov and accessing a non-NCUA website. We encourage you to read the NCUA's exit link policies. (opens new page).) )
HELOCs and home equity loans compared
- Home equity loans
- A fixed interest rate
- Lump sum
- Home equity line of credit
- An adjustable interest rate
- A fixed interest rate (Some lenders allow conversion to fixed rate)
- Draw money as you need it
- Pay interest only on the amount you draw
- Interest-only payments option
Learn more about Home Equity Loans by reading the Federal Trade Commission’s article on Home Equity Loans and Credit Lines
- Home equity loans
Home Equity Loans
A home equity loan is a loan for a fixed amount of money that is secured by your home. You repay the loan with equal monthly payments over a fixed term, just like your original mortgage. The amount that you can borrow usually is limited to 85 percent of the equity in your home. The actual amount of the loan also depends on your income, credit history, and the market value of your home.
Home Equity Line of Credit
A home equity line of credit — also known as a HELOC — is a revolving line of credit, much like a credit card. You can borrow as much as you need, any time you need it, by writing a check or using a credit card connected to the account. You may not exceed your credit limit. Because a HELOC is a line of credit, you make payments only on the amount you actually borrow, not the full amount available. HELOCs also may give you certain tax advantages unavailable with some kinds of loans. Talk to an accountant or tax adviser for details.
Like home equity loans, HELOCs require you to use your home as collateral for the loan. This may put your home at risk if your payment is late or you can't make your payment at all. Loans with a large balloon payment — a lump sum usually due at the end of a loan — may lead you to borrow more money to pay off this debt, or they may put your home in jeopardy if you can’t qualify for refinancing. And, if you sell your home, most plans require you to pay off your credit line at the same time.
Three-Day Cancellation Rule
Before you sign, read the loan closing papers carefully. If the loan isn’t what you expected or wanted, don’t sign. Either negotiate changes or walk away. You also generally have the right to cancel the deal for any reason — and without penalty — within three days after signing the loan papers.
Federal law gives you three days to reconsider a signed credit agreement and cancel the deal without penalty. You can cancel for any reason but only if you are using your principal residence — whether it’s a house, condominium, mobile home, or house boat — as collateral, not a vacation or second home.
Under the right to cancel, you have until midnight of the third business day to cancel the credit transaction. Day one begins after:
- you sign the credit contract;
- you get a Truth in Lending disclosure form containing key information about the credit contract, including the APR, finance charge, amount financed, and payment schedule; and
- you get two copies of a Truth in Lending notice explaining your right to cancel.
For cancellation purposes, business days include Saturdays, but not Sundays or legal public holidays. For example, if the events listed above take place on a Friday, you have until midnight on the next Tuesday to cancel.
During this waiting period, activity related to the contract cannot take place. The lender may not deliver the money for the loan. If you’re dealing with a home improvement loan, the contractor may not deliver any materials or start work.
If You Decide to Cancel
If you decide to cancel, you must tell the lender in writing. You may not cancel by phone or in a face-to-face conversation with the lender. Your written notice must be mailed, filed electronically, or delivered, before midnight of the third business day.
If you cancel the contract, the security interest in your home also is cancelled, and you are not liable for any amount, including the finance charge. The lender has 20 days to return all money or property you paid as part of the transaction and to release any security interest in your home. If you received money or property from the creditor, you may keep it until the lender shows that your home is no longer being used as collateral and returns any money you have paid. Then, you must offer to return the lender’s money or property. If the lender does not claim the money or property within 20 days, you may keep it.
If you have a bona fide personal financial emergency — like damage to your home from a storm or other natural disaster — you can waive your right to cancel and eliminate the three-day period. To waive your right, you must give the lender a written statement describing the emergency and stating that you are waiving your right to cancel. The statement must be dated and signed by you and anyone else who shares ownership of the home.
The federal three day cancellation rule doesn’t apply in all situations when you are using your home for collateral. Exceptions include when:
- you apply for a loan to buy or build your principal residence
- you refinance your loan with the same lender who holds your loan and you don’t borrow additional funds
- a state agency is the lender for a loan.
In these situations, you may have other cancellation rights under state or local law.
What happens if you can’t repay your home equity debt?
Your home secures the amount that you borrow through a home equity loan or line of credit. If you don't pay your debt, the lender may be able to force you to sell your home to satisfy the debt.