Fixed Home Equity Loan vs. Variable Home Equity Line of Credit

Jul 2, 2010 Jerry Barker

Finance nowadays resembles a byzantine maze, and of course confusion ensues. The lexicon is massive; the notions are complex, the investment options nearly infinite. This article will only focus on two of the most common lending solutions, the fixed home equity loan and the variable line of credit home equity loan. Reading Home Equity Loan Basics is recommended prior to reading this article.

What is Equity Lending?

Both are forms of loans (a loan is temporary provision of money that is accompanied by an interest rate on the repayment) where the equity of a home is used as collateral. To go further in depth, equity itself is the difference between the value of a property (as defined by the market) and the claims held against it; for example, if a piece of property worth $700,000 has a mortgage on it for $300,000, the equity would be $700,000-$300,000, or $400,000.

How Much can be Borrowed?

The amount is dependent on the value of the equity being using as collateral. In the example above, $400,000 would normally be the maximum amount that could be borrowed since that’s exactly how much equity is left in the property. However, $700,000 could be borrowed as long as $300,000 of it is used to pay off the first mortgage. While these figures are plain and simple to a degree, all financial institutions are not created equal and will have their own set of guidelines and policy’s that will restrict them to certain extents.

The Fixed Home Equity Loan

While both types of equity loans are fundamentally similar; their key difference is the “fixed” and “variable” parts of their names. The fixed version is a loan that comes with an unchanging interest rate and payment for a predetermined period of time; for example, a 15-year loan of $10,000 with an interest rate of 7% will have a payment around $90.00, that interest rate of 7% and the payment of $90.00 would never budge for 15 years or until the loan was paid in full.

The Variable Home Equity Loan

On the other hand the variable version is almost formless in a sense. The balance of the loan, the payment due, and the interest rate being charged can change anytime during the life of the loan, which also may not be predetermined. The balance can go up or down depending on what the borrower uses or pays back, this along with periodic interest rate changes can cause the monthly payment to go up or down as well.

Is a Fixed Home Equity Loan Better?

Now, the fundamental question, which type of loan is the better option for the average consumer? Well, the answer isn’t exactly straightforward. In general, a fixed rate is better for consumers who appreciate it’s stability or when taken during an economic crisis when interest rates are down. When the economy starts to rebound and everyone with variable rates see their monthly interest rates and payments go up, fixed rate consumers will be sitting comfortably at a low fixed, and therefore unchangeable, rate.

Is a Variable Equity Loan Better?

A variable rate is preferable during periods of economic prosperity, as the boom and bust cycle pretty much assures that rates will go down at certain points whilst the fixed rate would remain high. Variable rates are also preferable in that they follow the economic situation and thus loosely follow a consumer’s economic situation. To read more about HELOCs check out this article: The Top Five Reasons to Choose a HELOC.

What Makes it a Variable Home Equity Loan?

Variable HELOCs are more similar to credit cards then anything, but it’s the changing interest rate and type of collateral that give them their name. After these loans are disbursed, the interest rates get revised periodically every time a determined amount of time has passed. The changes could be quarterly, annually, tied to an index, or even a combination of an index and time.

What is an Index?

These interest rate revisions are usually based on major indexes such as the LIBOR or Prime Rate. An index is a sole number calculated from a set of prices or of quantities; hence it is representative of the situation as a whole, like an economy for example. Banks usually push variable rates because this type of loan allows them to transfer the interest rate risk to the consumer.

Hopefully now, the concepts of the fixed home equity loan and the variable line of credit home equity loan are slightly clearer. Making the right choice isn’t compromised of a simple option between black and white; one needs to have the right know-how to be able to accurately analyze their situation and make the right choice.

Equity Mortgage

Tuesday, July 20, 2010

Equity Mortgage - Fixed Home Equity Loan vs. Variable Home Equity Line of Credit