Using a home equity credit line to
borrow against the equity in your home has become a popular source of
consumer credit. And lenders are offering these home equity credit
lines in a variety of ways.
You will find most loans
come with variable interest rates, some come with attractive low
introductory rates, and a few come with fixed rates. You also may find
most loans have large one-time upfront fees, others have closing costs,
and some have continuing costs, such as annual fees. You can find loans
with large balloon payments at the end of the loan, and others with no
balloons but with higher monthly payments. No one loan is right for
every homeowner. The challenge, then, is to contact different lenders,
compare options, and select the home equity credit line best tailored
to your needs.
Be sure to review the home
equity contract carefully before you sign it. Do not hesitate to ask
questions about the terms and conditions of your financing.
Is a home equity credit line for you? Home equity lines: Initially
at least, they may provide you with large amounts of cash at relatively
low interest rates. And they may provide you with certain tax
advantages unavailable with other kinds of loans. (Check with your tax
adviser for details.
At the same time, home
equity lines of credit require you to use your home as collateral for
the loan. This may put your home at risk if you are late or cannot make
your monthly payments. Those loans with a large final (balloon) payment
may lead you to borrow more money to pay off this debt.
Because home equity loans give you
relatively easy access to cash, you might find you borrow more
freely.
Remember too, there are
other ways to borrow money from a lending institution.
Second Mortgages: You
may want to explore second mortgage installment loans. Although these
plans also place an additional mortgage on your home, second mortgage
money usually is loaned in a lump sum at a fixed interest rate with fixed payment amounts.
You also may want to
explore borrowing from credit lines that do not use your home as
collateral. These are available with your credit cards or with
unsecured credit lines that let you write checks as you need the money.
In addition, you may want to ask about loans for specific items, such
as cars or tuition.
How much money can you borrow on a home equity credit line?
Depending on your
creditworthiness and the amount of
your outstanding debt, home equity lenders may let you borrow up to 85%
of the appraised value of your home minus the amount you still owe on
your first mortgage. Ask the lender about the length of the home equity
loan, whether there is a minimum withdrawal requirement when you open
your account, and whether there are minimum or maximum withdrawal
requirements after your account is opened. Inquire how you gain access
to your credit line -- with checks, credit cards, or both.
Also, find out if your home
equity plan sets a fixed time -- a draw period -- when you can make
withdrawals from your account. Once the draw period expires, you may be
able to renew your credit line. If you cannot, you will not be
permitted to borrow additional funds. Also, in some plans, you may have
to pay your full outstanding balance. In others, you may be able to
repay the balance over a fixed time.
What is the interest rate on the home equity loan?
APR:Interest rates for loans
differ, so it pays to check with several lenders for the lowest rate.
Compare the annual percentage rate (APR), which indicates the cost of
credit on a yearly basis. Be aware that the advertised APR for home
equity credit lines is based on interest alone. For a true comparison
of credit costs, compare other charges, such as points and closing
costs, which will add to the cost of your home equity loan. This is
especially important if you are comparing a home equity credit line
with a traditional installment (or second) mortgage, where the APR
includes the total credit costs for the loan.
Variable Interest Rates:In addition, ask about the
type of interest rates available for the home equity plan. Most home
equity credit lines have variable interest rates.
These variable rates
may offer lower monthly payments at first, but during the rest of the
repayment period the payments may change and may be higher.
Fixed
interest rates, if available, may be slightly higher initially than
variable rates, but fixed rates offer stable monthly payments over the
life of the credit line.
If you are considering a
variable rate:
Check and compare the terms.
Check the periodic cap,
which is the limit on interest rate changes at one time.
Check
the lifetime cap, which is the limit on interest rate changes
throughout the loan term.
Ask the lender which index is used and how
much and how often it can change. An index (such as the prime rate) is
used by lenders to determine how much to raise or lower interest rates.
Check the margin, which is an amount added to the index that
determines the interest you are charged.
Conversion: inquire whether
you can convert your variable rate loan to a fixed rate at some future
time.
Discount Rate: Lenders can offer a
temporarily discounted interest rate. A rate that is unusually low
and lasts only for an introductory period, such as six months. After the introductory
period ends, your rate (and payments) increases to the true
market level (the index plus the margin). So, ask if the rate you are
offered is "discounted," and if so, find out how the rate will be
determined at the end of the discount period and how much larger your
payments could be at that time.
What are the upfront closing costs?
When you take out a home
equity line of credit, you pay for many of the same expenses as when
you financed your original mortgage. These include items such as an
application fee, title search, appraisal, attorneys' fees, and points
(a percentage of the amount you borrow). These expenses can add
substantially to the cost of your loan, especially if you ultimately
borrow little from your credit line. You may want to negotiate with
lenders to see if they will pay for some of these expenses.
What are the continuing costs?
In addition to upfront
closing costs, some lenders require you to pay continuing fees
throughout the life of the loan. These may include an annual membership
or participation fee, which is due whether or not you use the account,
and/or a transaction fee, which is charged each time you borrow money.
These fees add to the overall cost of the loan.
What are the repayment terms during the loan?
As you pay back the loan,
your payments may change if your credit line has a variable interest
rate, even if you do not borrow more money from your account. Find out
how often and how much your payments can change. You also will want to
know whether you are paying back both principal and interest, or
interest only.
Even if you are paying back some principal, ask whether
your monthly payments will cover the full amount borrowed or whether
you will owe an additional payment of principal at the end of the loan.
In addition, you may want to ask about penalties for late payments and
under what conditions the lender can consider you in default and demand
immediate full payment.
What are the repayment terms at the end of the loan?
Ask whether you might owe a
large payment at the end of your loan term. If so, and you are not sure
you will be able to afford the balloon payment, you may want to
renegotiate your repayment terms.
When you take out the loan, ask about
the conditions for renewal of the plan or for refinancing the unpaid
balance. Consider asking the lender to agree ahead of time and in
writing to refinance any end-of-loan balance or extend your repayment
time, if necessary.
What safeguards are built into the loan?
One of the best protections
you have is the Federal Truth in Lending Act, which requires lenders to
inform you about the terms and costs of the plan at the time you are
given an application. Lenders must disclose the APR and payment terms
and must inform you of charges to open or use the account, such as an
appraisal, a credit report, or attorneys' fees. Lenders also must tell
you about any variable-rate feature and give you a brochure describing
the general features of home equity plans.
The Truth in Lending Act
also protects you from changes in the terms of the account (other than
a variable-rate feature) before the plan is opened. If you decide not
to enter into the plan because of a change in terms, all fees you paid
earlier must be returned to you.
Because your home is at
risk
when you open a home equity credit account, you have three days to
cancel the transaction, for any reason. To cancel,
you must inform the
lender in writing. Following that, your credit line must be cancelled
and all fees you have paid must be returned.
Once your home equity plan
is opened, if you pay as agreed, the lender, in most cases, may not
terminate your plan, accelerate payment of your outstanding balance, or
change the terms of your account. The lender may halt credit advances
on your account during any period in which interest rates exceed the
maximum rate cap in your agreement, if your contract permits this
practice.
