A Guide To Home Equity Loans
Written by: Andrew Colmes
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A Guide To Home Equity Loans
A home equity line of credit, called a HELOC, allows you to borrow against the equity you've built into your home, typically by using a debit card or writing checks against the available balance. Your credit line, or limit, is fixed, but you can make withdrawals up to that limit rather than receive the complete amount as a lump sum. Once you've repaid what you borrowed, you can then continue to reborrow it. In some cases, you'll commence payment as soon as you borrow. I other instances, you'll pay interest only and make a one-time full payment of principal at a pre-determined date. Or you might make interest-only payments for a set period before beginning to repay principal as well.
Good (and Bad) Reasons to Borrow
Before you make the decision to put your home on the line, consider any other financial options you have available to you. There are times when borrowing against your home makes sense and can work to your benefit. Then there are situations where borrowing against your home can be a very bad idea. For example, a good reason to borrow is sending a child to a private college. Need-based financial aid decisions take your assets into account, and that includes primary residences. It does not, however, consider your credit card debt. Consolidating your debt using home equity will more accurately reflect your financial situation. Opening a HELOC can also make a feasible choice if an unexpected financial emergency befalls you-provided, of course, you have a realistic plan as well as the means and the discipline to pay off the loan afterwards. Some unwise reasons to borrow include borrowing to invest in stocks or similar situations-this is a risky move with dangerous possible consequences, as many people have found out the hard way. The exception to this might be borrowing to grow your business, in which case you have the potential to transform debt into wealth. Borrowing to defer debt is also an unwise choice-consolidating credit card debt into a home equity loan puts your house at stake. And don't fall into the foolish trap of getting a HELOC just for the inherent tax deduction. You'll only lose money in the long-run that way.
Explore Your Options
Before you sign any dotted lines, be sure to do some shopping around. Start with your primary lender and then look into other options. A difference of even 0.1 % higher than the prime rate can equal thousands of extra dollars in payment. Understand the terms before you make any decisions. Home equity loans are unfamiliar territory for many people. It's a good idea to speak with a financial advisor or tax professional before you make any decisions. They can clue you into financial events looming on the horizon. HELOCS are variable rate, not fixed rate loans. They will usually open with a lower rate and then rise after a set introductory period. Find out both the floor and ceiling rates of the loan. HELOCS are required by law to have a ceiling or cap, the maximum the interest rate may increase to. The variable rate must be based on a publicly available index, such as the prime rate published in the Wall Street Journal. Also keep in mind that the APR for a home equity loan does not include the closing costs and other associated fees and charges.
Weigh the Pros and Cons
Home equity loans have some clear advantages over an unsecured loan. Since the lender carries lower risk thanks to their holding your property as collateral, they can afford to offer you lower interest rates that they could with unsecured loans. And interest on the first $100,000 you borrow against your house is tax deductible. On the other hand, you have to weigh the cons. The most obvious is you could lose your home. In addition, your real estate's value may be adversely affected and you could find yourself owing more than you can get should you try to sell your home. If relocation is imminent in your near future, a home equity loan is probably not the way to go as you will be required to pay off your loan in full immediately when you sell the house. The terms of your loan agreement can also prohibit you from renting out your house.
Know Your Rights
Finally, be aware if your rights in the process of applying for and agreeing to a home equity loan. The Federal Reserve stipulates you should receive information in writing on each mortgage or home equity loan you consider before you pay any fees. A provision in the Truth in Lending Act gives you the right of rescission-the right to cancel a real estate loan within three business days without penalty. With a home equity loan, you can rescind only when using your primary place of residence as collateral. The rule does not apply to vacation properties or second homes. And remember, never be afraid to get clarification from a lender or broker about index rates, margins, or anything else you might be unsure of.
