Dear Mary: We have decided to pay off a bunch of bills and do some much-needed repairs on our house. Can you tell me the difference between a home equity loan and a home equity line of credit? Which would be better? — Scott
Dear Scott: With a home equity loan, or a HEL, you walk away with a check for the full amount of the loan and a second mortgage on your home. You will likely pay a loan fee and closing costs. Interest rates are fixed and currently average around 5%.
A home equity line of credit, or a HELOC, is a revolving line of credit, a lot like a credit card, except that your home is the collateral. You don’t get a check at closing, but rather a checkbook or debit card to access the funds as you need them. You make payments on the amount you’ve drawn out, not the total amount you have available. Rates on HELOCs now start at about 2.5%.
A HELOC has several drawbacks you should know about. First, the interest rate will, more than likely, be variable. It looks very low now but could go through the roof quickly if the economy continues to rebound and the Federal Reserve Board increases interest rates.
A HELOC could wreak havoc on your credit score if you draw out the maximum amount available. Because it is a line of credit, it will appear that you are borrowing faster than you can repay in the same way a maxed-out Visa or MasterCard account pulls down your credit score.
Something else to consider: Most lenders charge hefty fees on HELOCs, including an annual fee of $50 to $75 just to keep the line open. Many HELOCs provide for a penalty of $250 to $600 if you pay it all back during the first three years. And if you get it and then don’t draw on it? Expect a “nonusage” penalty of $50 a year.
Finally, in both cases — HEL and HELOC — should you fall behind in making those regular payments, the lender will not think twice about taking whatever measures necessary to collect, including foreclosing on the house. Just make sure you are fully aware of what you are getting into.
I know it’s a coincidence, but “HEL” is certainly an appropriate acronym for spending one’s home equity. While you didn’t ask my advice, I hope you have thought this through. Treating your home equity like available spending money could be a decision you will regret for a long time to come.
Dear Mary: Enclosed with my electric bill this month was an offer to buy an insurance plan that will cover the costs associated with repairing my furnace, water heater, range and refrigerator. The cost is $14.99 per month. Would this be a good idea? — Tamara
Dear Tamara: Without the specific details of the offer, I’m at a decided disadvantage. But I can tell you that $14.99 a month becomes $179.88 in a year. Personally, I can’t recall when I required repairs on any of the four appliances you mention; it’s been that long, if ever.
My point is the odds are in the company’s favor. Here’s my advice: If you have $14.99 a month to spend, set up your own protection account. Write yourself a check every month, and if something needs repair, pay for it from that account. More than likely, after a year, you will have a nice nest egg to do with as you please.
Mary invites you to visit her at EverydayCheapskate.com, where this column is archived complete with links and resources for all recommended products and services. Mary invites questions and comments at https://www.everydaycheapskate.com/contact/, “Ask Mary.” Tips can be submitted at tips.everydaycheapskate.com/. This column will answer questions of general interest, but letters cannot be answered individually. Mary Hunt is the founder of EverydayCheapskate.com, a frugal living blog and the author of the book Debt-Proof Living.