A home equity loan or line of credit allows you to borrow against the equity in your home. The loan may provide you with access to a significant amount of money.
Before taking out a home equity loan:
- Review your financial situation and needs; and
- Shop around between lenders for the best possible deal.
In most cases it is easier to obtain a home equity loan than other forms of credit, due to the fact that the loan balance is secured by the equity in your home. At the same time, if you overextend yourself with a home equity loan you may put yourself at risk of foreclosure.
Investigating Your Home Equity Options
When evaluating lenders and their home equity loan offerings, make sure that you understand the loan and how it suits your needs.
Get information about the loan
The terms of home equity loans will vary, and loans that initially seem similar may in fact have different costs for closing and repayment.
- Get information on the interest rate.
- Will interest be variable, as is common with home equity loans, or will interest be assessed at a fixed rate?
- If the rate is variable, does the loan include a rate cap and what is the amount of the cap?
- If you later want to do so, can you convert your variable rate home equity loan to a fixed rate loan without refinancing?
- What are the closing fees and costs for the loan?
Home Equity Loan vs. Home Equity Line of Credit
When borrowing against your home equity, you may seek either a home equity loan, or a home equity line of credit (HELOC).
- Home Equity Loan: You receive a fixed amount of money upon closing the loan.
- Home Equity Line of Credit: You typically receive a checkbook and may write checks that are drawn against the equity in your home up to the amount of the line of credit.
The annual percentage rate (APR) for a home equity loan typically incorporates points and finance charges, whereas the APR for a line of credit normally reflects only the interest rate charged. You should consider that difference when calculating the total cost of a loan versus the cost of a line of credit.
If you obtain a home equity line of credit, you should make sure you understand all of the terms of the line of credit. For example:
- Are you required to make monthly payments toward the total principal of your debt, or will are you required to pay only the interest?
- When will you have to repay the balance of the line of credit?
- Under what circumstances may the lender limit your line of credit?
- Do you have to pay an annual fee for your line of credit even if you have not borrowed any money?
Fees and Costs
Know the fees associated with your home equity loan. If you will be moving relatively soon, consider if it will be worth borrowing against your home given the fees you will incur.
Before you borrow money against your home equity, be certain that you understand the terms of repayment. Make sure that you understand the amount of any fees that may become due upon repayment.
If you may soon be moving to a different home, you should consider what fees you may incur as a result of borrowing against your home, including the fees you will have to pay when you sell your home and pay off the loan, and whether it is best to defer borrowing until after you relocate.
Watch for inappropriate conduct by home equity lenders, including the following:
Bait and Switch
The lender offers one set of loan terms when you apply for the loan, attempts to impose higher charges when you sign to complete the transaction. Such a lender may attempt to distract you from the terms of the contract, to use pressure tactics to get you to sign or prevent you from reading its terms, or may even misrepresent what the contract says.
The lender gives you a loan based on the amount of equity in your home, even though you will find it difficult or impossible to make the loan payments given your income. If you are unable to make your payments you may lose your home.
Credit Insurance Packing
The lender adds credit insurance to your loan, perhaps at a substantial cost, even though you may not want or need credit insurance.
If you must obtain credit insurance, consider applying for coverage through a source other than the lender so that you can take advantage of any less expensive option.
The lender encourages you to repeatedly refinance your loan, perhaps also encouraging you to borrow additional funds each time you refinance. Each time you refinance the loan you pay additional fees and points which return profit to the lender, but also increase your debt.
Deceptive Loan Servicing
The lender provides inaccurate, incomplete, or misleading account statements and payoff figures. As a result, it is extremely difficult for you to determine how much you have paid or how much you owe, and you may end up paying more than you actually owe.
For tips on getting a good deal and protecting yourself from deceptive lending practices, please see this associated article.