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Five Things to Consider When Shopping for a Home Equity Loan

Before you rush to apply for a home equity loan, you will want to give serious consideration to how you intend to use the funds, since you are using your home as collateral.

Before you rush to apply for a home equity loan, you will want to give serious consideration to how you intend to use the funds, since you are using your home as collateral. To assist you in making the right decision, here are some potential risks you will want to be aware of:

  • Know your upfront costs. There may be costs for taking out a home equity loan. By comparing several lenders' rates and fees, you can make a better decision. Do not be afraid to question your lender about a fee you do not understand.
  • Getting a home loan is not temporary. While qualifying for the funds you need may be easy, taking on a long term payment could be detrimental to your financial goals. Replacing one debt with another may not be the best solution.
  • Beware of the balloon payment.Obtaining a low-interest rate home equity line of credit (HELOC) may require making a balloon payment at some point in time. Unless you decide to refinance, take out another loan, or sell your home before the payment is due, you may have to pay off the balance on your loan.
  • Be careful not to overspend. Since a home equity line of credit acts like an open line of credit you may be tempted to use your access card or write a check each time you need an infusion of cash. You might be better off saving these funds for large purchases. It is always best to have a goal and a repayment plan that works for you.
  • Beware of the maximum loan-to-value. Most financial institutions will let you borrow up to 80% of the loan-to-value (LTV) ratio of your home less any outstanding mortgage payments on your property. Some lenders may offer 85% or 90% LTV but those can come with higher rates. Always ask for their best offer. Be careful not to max out your equity, in case home values decrease.

What is a Home Equity Loan?

A home equity loan is a loan in which the borrower uses the equity in their home as collateral. Your home's equity is equal to its market value minus any mortgages or other liens owed on it.

A home equity loan is a loan in which the borrower uses the equity in their home as collateral. Your home's equity is equal to its market value minus any mortgages or other liens owed on it. Compare home equity rates.

In the early stages of your first mortgage loan, the majority of your monthly mortgage payments goes toward paying down the interest, but once you begin to make principal payments, the amount of equity in your home increases. Then, as your home appreciates over time, its equity grows even faster. The opportunity to use this equity is one of the benefits of homeownership.

Why do people use home equity loans?

As a financial tool, home equity loans can help you achieve many of your goals. The attractive rates can be lower than those of a personal loan or unsecured credit card - not to mention the added benefit of being tax deductible in most cases (always check with your tax or financial advisor before making any tax-related decisions).

A popular use of a home equity loan is for home renovations or repairs. By improving your home you are putting money back into your house, which can increase its value. Other reasons homeowners use home equity loans include:

  • Adding a room as their family grows
  • Purchasing a new car
  • Adding or renovating a pool
  • Taking that dream vacation
  • Paying for their child's education
  • Paying off outstanding debts
  • As emergency cash should unforeseen expenses arise

If you are a homeowner looking to use your home as a financial resource, then a home equity loan or home equity line of credit may be right for you. Always shop online to find the best home equity product that meets your specific needs. Compare home equity rates.

Home Equity Line of Credit Versus Credit Cards

While both sources of financing - home equity lines of credit and credit cards - are revolving, or open-ended, and therefore can be used for the same types of expenses, it is important to know the differences between them so you can use them as wisely as possible.

While both sources of financing - home equity lines of credit and credit cards - are revolving, or open-ended, and therefore can be used for the same types of expenses, it is important to know the differences between them so you can use them as wisely as possible.

Similarities

The similarities between home equity lines of credit and credit cards include:

  • They are open-ended. With both home equity lines of credit and credit cards, you have ongoing access to your funds. Therefore, you can use both of them to finance ongoing expenses.
  • They have special rates. Both credit cards and home equity lines of credit can offer low introductory rates.
  • They have variable interest rates. On most credit cards and HELOCs, the interest rate is variable. That means that it is tied to a specific index; in most cases prime is used. When prime drops, your interest rate drops, and when it goes up, the rate goes up.
  • They have card offers. Obviously, when you have a credit card, it is the medium through which you access your credit. Similarly, with a home equity line of credit, you have the option of getting a card to access your line of credit. Typically, HELOC usage is by writing a check.

Differences

Following are some of the differences between home equity lines of credit and credit cards:

  • Limitations. Most HELOCs have a specific period in which funds can be accessed, whereas credit cards do not. All HELOCs and credit cards are subject to cancellation based on payment history.

 

 

  • Lower interest rates. The interest rates on home equity lines of credit are typically lower than those on credit cards after any introductory period.
  • Tax benefits. The interest on a home equity line of credit is usually tax-deductible, whereas that on a credit card is usually not.

Do's

  • Many consumers use their equity to help fund their children's college education. This is ordinary perceived to be a good use of it because it is a good investment in their future.
  • Another very popular use of a home equity line of credit is to finance a home improvement or renovation project. The benefit of having access to your funds can be combined with the benefit of putting money into your house and increasing its value and its equity for future use.

Don't's

  • You should not use your home equity line of credit for frivolous expenses. Some HELOCs have a minimum advance requirement, resulting in an inability to make everyday purchases with your line of credit. Also, most credit cards offer rewards programs, and HELOCs do not. Therefore, let your credit card cover everyday expenses and earn rewards, and use your HELOC for large purchases.
  • Because of the favorable interest rates and tax savings, some people advise using a home equity line of credit to pay off high-interest credit card debt. If you find yourself not paying your credit card in full each month, then it might be wise to use your home equity line of credit to consolidate and pay off your debt. Be careful - once you pay off your credit card debt, do not run it up again. If you are going to pay off your debt, and stay debt-free, then using your home's equity is a good way to go. But do not take this route if there is a chance you will find yourself in credit card debt again.

Home Equity Glossary

Here are some commonly used home equity terms.

Compare home equity rates.

Access card

- A machine readable card that allows you to access your HELOC account.

Affordability calculator

- One of many calculators on the Internet which estimates how much loan a person can afford to borrow.

Amortization

- The process of regular repayments at scheduled intervals to reduce the principle and repay interest as it is due.

Annual percentage rate (APR)

- The cost of a loan expressed as a yearly rate, which includes the interest rate, points, broker fees, insurance, and any other related fees a borrower is required to pay.

Annual fee

- An annual charge imposed by the lender for maintaining a loan.

Application fee

- A fee charged by the lender to cover the cost of processing a loan request and checking the borrower's credit.

Appraisal fee

- The fee an appraiser charges to assess the value of a property.

B

Balloon

- A final lump sum loan payment due in full after a set period of time.

Borrower(s)

- A person who borrows money from a lender.

C

Cap

- A limit on how much the variable interest rate can increase annually, semi-annually, or during the life of the line of credit.

Closing costs

- Fees and expenses (separate and in addition to the purchase price of the property) incurred in the process of transferring ownership of property. May also be called settlement costs.

Conversion fee

- Points or an increased rate paid for converting an adjustable rate mortgage to a fixed rate mortgage.

Credit history

- A borrower's record of repaying loans and use of revolving credit. Used by lenders to assess applicant's creditworthiness.

Credit score(s)

- A statistical method that lenders use to quickly and objectively assess the credit risk of a loan applicant.

Draw period

- The timeframe when you can withdraw money from a home equity line of credit. After the draw period expires, the repayment period generally follows.

E

Equity

- The current market value of a property minus any outstanding loans or liens.

F

Fair Isaac Corporation (FICO)

- The company that developed the FICO credit score, which is used to judge a borrower's creditworthiness.

Fixed rate loan

- A fixed interest rate loan, or installment loan, that does not change or adjust during the course of the loan.

H

Home equity loan (HEL)

- A fixed rate loan secured by a primary residence or second home, to the property's fair market value.

Home equity line of credit (HELOC)

- A form of revolving credit in which your home serves as collateral.

I

>Index

- A published cost of money measurement that lenders use to calculate the rate on a mortgage (e.g., T-bill, LIBOR, CMT.)

Internet

- A global communication network that allows computers worldwide to connect and exchange information.

Interest-only

- A non-amortized loan where interest is due at regular intervals until maturity, at which point the full principle on the loan is due.

Interest rate

- A rate that is charged for the privilege of borrowing money.

L

Lender(s)

- A person or company which lends money to borrowers.

Loan-to-value (LTV) ratio

- The ratio of the fair market value of the home to the value of the loan that it is securing.

Loan officer

- The person at a lending institution who solicits loans, acts as the representative for the lending institution, and represents the borrower at the lending institution.

M

Margin

- The difference between the interest rate and the index on a loan.

Mortgage

- A lien on real estate to secure repayment of a loan.

Mortgage payment

- The monthly payment amount owed to a lender which covers the principal and interest on a property.

N

Negative equity

- When the current market value of a property is less than the amount owed.

P

Point(s)

- An upfront fee that a lender may charge a borrower for originating a loan. One point is equal to one percent of the loan amount.

Pre-payment penalty

- A fee paid to a lender for the privilege of paying off a loan prior to maturity.

Prime Rate

- A standardized short-term borrowing rate established by the Federal Reserve Board.

Principal and interest(P&I)

- The actual loan amount and interest paid back to the lender in the form of monthly payments.

R

Realtor

- A member of the National Association of Realtors.

Refinance

- Paying off an existing loan with the proceeds from a new one, usually of the same size and using the same property as collateral.

S

Sub-prime

- A class of loans that is offered to individuals with less-than-perfect credit.

Teaser rate

- A special introductory rate on a loan or line, usually tied to a specified period of time, which is below current market rates to entice borrowers.

Transaction fee

- The amount a borrower is charged for each withdrawal on a line of credit.

V

Variable rate

- An interest rate that may change periodically, and is usually based on an in index and a margin that is predetermined.

W

Withdrawal

- The act of drawing funds from a home equity line of credit, normally using special checks or access cards.

Copyright 2009, Informa Research Services, Inc. ("Informa"). While all attempts have been made to provide effective, verifiable information in this article, neither the author nor Informa assumes any responsibility for errors, inaccuracies, or omissions. You should always seek the guidance of a licensed professional before making any major financial decisions.

What is a Home Equity Loan Going to Cost You

While home equity loan products can offer money-saving opportunities for homeowners, attractive interest rates can be offset by the added expense of fees and/or closing costs. When comparing lenders' rates, be sure to find out if there is a discount for having the lender pay closing costs.

While home equity loan products can offer money-saving opportunities for homeowners, attractive interest rates can be offset by the added expense of fees and/or closing costs. When comparing lenders' rates, be sure to find out if there is a discount for having the lender pay closing costs. Compare home equity rates.

The interest rates and fees on a loan can vary based on the amount you are borrowing plus how much equity you have available. Lenders may provide existing customers with special introductory or teaser rates which adjust upward after an initial period of time. Some fees to be aware of are:

  • Annual Account Maintenance
  • Application
  • Closing costs (may include credit report, appraisal, title search, flood evaluation, recording fees, attorney fees, and taxes in some states)
  • Loan origination (points)
  • Pre-payment penalty
  • Some competitive loan offers include no fees, no points, and no closing costs. Make sure all fees are disclosed upfront, and inquire how they will affect your final interest rate.

Also, some banks offer a relationship banking product, in which you get special benefits by having multiple accounts at one bank. You should look into whether your bank offers this product, so that you can use your home equity loan to help you waive fees and receive additional benefits on your checking and savings accounts.