What
You Need Know About Home Equity Loans?
It's easy to see why home
equity loans and lines of credit have become so popular. Borrowers like the fact
that interest rates on these loans are generally lower than the going rates on
credit cards, car loans, and other financing options. They also welcome the tax
deduction that comes with a home equity loan, should they itemize their
deductions on their tax return. Banks like home equity loans and lines of credit
because the loans are secured by the borrower's home – and not just by his or
her good intentions to repay. The caveat is that using your house as collateral
for a loan puts your home at risk if you should default. That's why experts
recommend that you carefully assess your borrowing needs and your ability to
repay before you jump on the home equity bandwagon.
Home Equity Borrowing Basics
Basically, there are two ways
to tap the equity in your home. The right choice for you depends on your needs.
If you're looking for a fixed, lump-sum amount, perhaps for a major home
improvement project, you're better off with a home equity loan. With a home
equity loan, the terms, and usually the interest rate and monthly payment,
remain the same over the life of the loan. If you want the convenience of
drawing against your credit line as the need arises, a home equity line of
credit is more likely to meet your objectives. Instead of borrowing a fixed
amount of money, you qualify for a certain amount of credit. You then can borrow
up to your credit limit whenever you want. You access the money as you need it,
usually by writing checks assigned to the account or by using a credit card
issued by the lender.
Whichever your preference, you
need to shop carefully for the best deal. By asking the following questions of
the lenders you are considering, you will be better prepared to make a
knowledgeable decision.
What Interest Rate
Am I
Paying?
Interest rates vary among
lenders, so check with several and compare the annual percentage rate (APR).
Don’t just look at the APR. For a true comparison of credit costs, compare
other charges, such as points, fees, and closing costs. If the lender is
offering an introductory "teaser" rate, be sure to find out what rate
you will be paying after the end of the introductory period.
What
Is The Index Based on
and How Often Can It Change?
The interest rate on a
variable-rate loan must be based on a publicly available index. Most lenders use
the prime interest rate. In today's market, you should look for a lender that
offers the prime interest rate for the life of your loan. In any case, you
shouldn't have to pay more than two points above prime. It's also important to
know how often the lender adjusts the rate.
How High Can the Rate Go?
Under current law, all
variable-rate plans must have a cap on how high your interest rate can climb
over the life of the plan. Most variable-rate lines of credit also have a cap
that limits how much and how often the interest rate can change during the
course of a year. That cap typically prevents your rate from rising more than
two percentage points in a single year.
What Are the Closing Costs?
Closing costs, which may
include (but are not limited to) a title search, appraisal, attorney fees,
recording charges, and notary fees, also vary from lender to lender. With
financial institutions competing fiercely for the home equity market, you should
be able to find a lender willing to waive some or all of the closing costs. But
shop carefully – some lenders that advertise zero closing costs do impose
hefty application fees or annual charges. Some lenders impose a fee each time
you access the account, and others charge you if you don't use the account.
Do I Have to Use My Credit
Line Right Away?
Some credit lines require that
you borrow a minimum amount upon opening your credit line. This is particularly
true in the case of advertised offers. This won't be a concern if you are
consolidating debts or otherwise plan to draw against your line right away. But
if you're opening a credit line for future or emergency needs, you'll want to
look for a credit line that doesn't require a minimum draw at closing.
What
Are My Repayment Terms?
Usually, you repay the loan in
regular installments. Paying more than the minimum monthly payment will pay off
the loan faster and reduce your costs. Unless it is absolutely necessary, avoid
interest-only repayment options in which you pay only interest during the term
of the loan and the balance is due at the end of the term. This option can be
much more costly.
Keep in mind that interest on home equity borrowing
of up to $100,000 is generally deductible. Consult with a tax advisor on how to
make the most of this deduction.