Home Equity Loans and Lines of Credit
Home equity
loans and lines of credit are both lucrative for lenders. This is why you might often find very tempting rates on these two products, making them hard to resist. However, a home equity loan or line of credit could well be your best borrowing option if you own a home and know how to shop around for a good deal.
Types of Interest Rates
There are two types of interest rates: fixed and variable. Both rates are typically based on an index, such as the prime rate, which is the lowest interest rate banks offer to their preferred borrowers. Lenders will then add a fixed percentage, or margin, to this index to determine what you will pay in interest. Generally speaking, this is not often more than three percent above the index rate.
Whereas a fixed rate ensures the interest rate will not change during the life of the loan, a variable rate fluctuates when the index it is based upon fluctuates.
If you choose a variable rate loan, make certain that you find out how much the interest rate can change over the life of the loan. Check as well to see if there is a cap that will prevent the rate from exceeding a certain amount. You typically would not want your rate to rise more than a maximum of five percentage points above where it started.
Caution: Be wary of super-low rates. Some lenders try to entice borrowers with low 'teaser' rates, which may well be very low for 6-12 months, but then skyrocket once this introductory period expires. To avoid any surprises, make sure you ask what the rate figures to be over the life of the loan. It should be based on the prime rate and, as with any home equity loan, not exceed it by much more than three percentage points. Also, make sure your loan payments cover both the interest AND the principal on the loan. Read the fine print and don't be afraid to ask questions!
Repayment Options:
There are 3 kinds of repayment options, allowing you to choose the best to suit your needs:
Pay the interest and a portion of the principal each month. This can cut down on your loan's duration as much as 5-20 years.
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Pay only the interest for 5-7 years. Once this period ends, you may renegotiate the loan terms, continuing to pay interest only, or you might start paying down the principal.
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Pay substantial amounts covering both the interest and the principal.
Obviously, the third repayment option will allow you to pay off the loan more quickly, saving you money in the long run.
Make sure, though, that you read that fine print on the loan - check to make sure that your loan does not include a penalty for pre-payments. These penalties can be significant, such as several months' interest on the remaining balance of the loan.
Add up those fees
If you take out a home equity loan or line of credit, you may be responsible for paying closing costs, which can include loan points and application, title search, appraisal, credit check, notary and legal fees. These fees can really add up! In fact, you may even find that a higher interest rate and lower fees at one bank may outweigh the benefits of a loan with lower rates and higher fees.
Finally, if you've obtained a line of credit, keep in mind that lenders sometimes charge maintenance fees to keep your line of credit open.
Remember: Shop around, read the fine print, and don't be afraid to ask questions!
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