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A Home Equity Loan: Is it right for you?
Section 2:
Shop, shop, shop, and read the fine print
Variations on the home
equity loan
| Q: |
Is the rate fixed or variable? |
| A: |
A fixed rate loan is
one in which the APR (annual percentage rate) is set and
doesn’t change over the life of the loan. This is usually
for a closed-end home equity loan.
A variable rate loan is usually for a home equity
line of credit. The APR is tied to an index and varies over
the life of the loan. If interest rates fall, then your
APR might be lower. The opposite is true if rates go up.
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| Q: |
What does it mean if there is a balloon
payment on the loan? |
| A: |
Sometimes the terms of a loan include a
balloon payment after a certain period of time, usually
two or three years. At that time you will have the option
to refinance or pay off the balance of the loan. You might
want a balloon payment after a certain period of time, for
example, if you know you plan to sell your home. Sometimes
the lender requires it if your credit rating is low. |
| Q: |
How long can I take to pay it back? |
| A: |
Home equity loan terms vary; 5-,
10- to 15-year loans are the most common. Depending on your
needs, this is something you and your lender will discuss.
Obviously, the longer you take to pay it back, the lower
your payments will be. However, the longer the term, the
greater the amount of interest you’ll pay over the
life of the loan. And, generally, the interest rate for
longer terms is higher.
Imagine that you want to borrow $10,000 to make some home
improvements. Look at the comparison below of a loan for
$10,000 for terms of 5 years and 10 years. |
| Loan
Amount: |
$10,000.00 |
$10,000.00 |
| Annual
Interest Rate: |
5.40% |
5.95% |
| |
| Length
of Loan (in Years): |
5 |
10 |
| Number
of Payments per Year: |
12 |
12 |
| Total
Number of Periods: |
60 |
120 |
| |
| Payment
Per Period: |
$190.55 |
$110.77 |
| Total
Interest Paid: |
$1,433.02 |
$3,292.35 |
| Total
Payments: |
$11,433.02 |
$13,292.35 |
| Q: |
What is a home equity line of credit? |
| A: |
Instead of borrowing a fixed amount for a fixed period
of time at a fixed rate, a home equity line of credit
allows you to pay interest only on what you borrow.
If you have a line of credit of $10,000 and spend $4,000
to landscape your yard, you’ll only pay interest
on that amount. You will have $6,000 remaining on which
you can borrow and as you pay down the television, your
available credit increases.
In that sense, it works much like a credit card, except
the interest is lower and it varies depending on the
interest rate currently in effect. Your lender will
set a time limit when no future advances will be allowed
and payments will simply be applied to all outstanding
debt.
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Compare rates, points and fees
A loan that looks like a good deal because of a low interest
rate could have higher closing costs, fees and points. It’s
always a good idea to get at least two proposals so you have
a comparison. It is also recommended that you shop with a financial
institution that you’re familiar with, perhaps the one
that has your mortgage.
- APR (annual percentage rate) is the percentage of
interest you will pay.
- A point equals 1% of the amount of the loan. Sometimes
called origination points by the lender.
- Fees are the costs the lender charges to cover the
expenses of making the loan.
One lender may offer very low interest rates, but is making
up for it in the closing costs, points and fees. Another lender
may have a rate that’s a little higher, but the closing
costs are lower. Each lender must provide you with a Good Faith
Estimate (GFE) (see an example)
of the expected closing costs within three days of submission
of the loan application. Compare these terms carefully.
Let’s say you have applied for a loan with two different
lenders. To determine the true cost of your home equity loan,
compare the items on the two GFEs. You can ask for an amortization
schedule of the loan, or do one yourself online—using
a mortgage
calculator or with software that’s right on your computer.
Add in the closing costs to the amount of your loan for the
amount financed (unless you will pay these up front).
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