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Home Equity Lines of Credit

Do you have equity in the home that you own now? Do you need money for college education, home improvements, a long awaited vacation or a new car? Whether you have any equity or not, you may be able to take advantage of borrowing opportunities that did not exist one year ago.

Equity is defined as the value in your home, and is calculated by subtracting all outstanding mortgages from the market value of the home. Because loan balances and housing prices are changing constantly, the equity that home owners fluctuates as well. Lenders are less concerned with the exact dollar amount of equity in a home than the percentage of equity. For example, a home owner with a $500,000 mortgage on a $525,000 home has $25,000 in dollar equity but less than 5% in percentage terms. On the other hand, the owner of a $60,000 condominium with a first mortgage of only $40,000 has $20,000 in equity which is 33% on a percentage basis. Lenders would prefer to lend additional funds to the condominium owner because of the higher percentage of equity.

In is important to understand equity percentages because the maximum percentage of combined loan to value on a property is what has changed dramatically over the past two years. In 1995, nearly all second mortgage lenders would not let the combined total of a borrower's first and second mortgage exceed 80% of the value of the property. A home owner with a $100,000 home and a $70,000 first mortgage could only borrow $10,000 (80% of $100,000 = $80,000 - $70,000 = $10,000). Today, that same home owner could not only borrow $30,000, the entire amount of the equity in the property, but could also borrow up to 125% of the value of the home. Unbelievable as it may sound, the borrower in the above example could actually obtain a loan for $55,000 in addition to the existing first mortgage.

Over the past two years, the number and type of home equity loans available to consumers has mushroomed as banks and finance companies have accumulated large amounts of cash that they need to lend back out to borrowers. The highly competitive nature of home equity lending has caused lenders to offer an increased number of programs to consumers. In addition to the usual rate competition, lenders continued to increase the maximum amount they would loan on a


property. Programs have leaped from 80% to 90% to 100%, and 1997 have topped out at 125%.

Credit standards have been relaxed to a certain extent as well. Two years ago, a borrower had to have excellent credit for a home equity line or second mortgage term loan. Now borrowers who do not meet normal credit requirements will not get rejected, but will be offered a loan at a higher rate under B-C-D credit programs. With all of the available programs and choices, consumers have much to consider when choosing a home equity program.

Home Equity Lines of Credit

The typical home equity line is a form of revolving credit in which a borrower's home serves as collateral. A borrower is approved for a specific amount of credit-the credit limit-which will become the maximum amount that can be borrowed under the plan. Lenders usually require the line to be at least $5,000 to $7,500, but total credit lines can range up to $500,000. Once the home equity line is in place, a borrower can borrow up to the credit limit at any time. Many plans require a minimum draw against the line of between $250 and $500.

The borrower is usually required to repay at least the miniumum interest due each month for the first ten years. The interest rate on home equity lines is variable, usually based on the prime rate (which was 8.5% in July 1997), and is capped at a maximum that ranges from 15% to 20%. At the end of that period, most plans will take the existing remaining balance and turn it into a 10 or 15 year fully amortizing loan. Of course, if these programs continue to prevail in ten years, a consumer could always take out a home equity line from another lender and gain an additional ten years of interest-only loan payments.

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