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Mortgage and Finance : Equity Lines of Credit Last Updated: May 14th, 2012 - 22:24:01

How to Use Equity Lines of Credit

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How to Use Equity Lines of Credit

Equity lines of credit are readily available today to anyone who owns stocks or real estate, including your home. A line of credit is issued by the lender, and you get a checkbook and a credit card to access the line. These automatic-access accounts are very help?ful for real estate buyers who lack substantial personal savings because they allow you to move quickly when you see a good deal. You simply write a check that is used as your escrow deposit.

As with so many other mechanisms in the investing world, however, there are dangers inherent in lines of credit. If you don't have the ability to pay them back, they can ruin you. How might this happen? Well, all lines of credit feature adjustable, rather than fixed, interest rates. As of this writing, interest rates are relatively low. But these rates can he adjusted every month, and, if they go up, the cost of your past borrowing goes up, too. While this doesn't normally result in a rapid change in your monthly payment, the impact of gradually rising interest rates can sneak up on you.

Eventually, you can find yourself in a negative amortization situation. Simply put, a negative amortization occurs when your payments on the loan are less than the monthly minimum required to pay off the loan. In theory, depending on the terms of your loan, the lender has the right to "call the loan" and seize and sell your collateral—which means foreclosure, in the case of real estate collateral. More likely, since your loan is secured by real estate, the lender will simply let the loan increase in size, on the assumption that your equity is increasing faster from appreciation. So while foreclosure is an extreme example of what could happen through misuse of a line of credit, it is something that any borrower should understand and make allowances for.

Is the risk inherent in lines of credit worth the reward? You have to answer this question for yourself. Frankly, we use lines of credit all the time, but we tend to be aggressive investors. Especially in the real estate market of today, opportunities don't last very long. You need to have the ability to move quickly in order to take advantage of good deals that may come your way. At the same time, you shouldn't do things that take you out of your own risk tolerance or if things go badly put pressure on you that you're not prepared to deal with. You need to figure out your own way to participate in the real estate business.


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