Deciding to get a home equity loan is easy. Deciding what kind of loan can look a lot more complicated. Don’t worry, it’s easier than you think – once you know the basics.
Home equity loans are a way of borrowing against the equity in your home. And, because the loans are secured by your home, lower interest rates are often available.
Sure, the choices of how to use the money are unlimited (and can be exciting). Home equity loans are attractive for those that want to do home improvements, use the money for investments or pay off those irritating higher-interest credit card balances or consumer loans. Also, ask your lender about the tax benefits of a home equity loan.
But the choices of which kind of loan are more limited. It really comes down to two options: a fixed rate loan or an adjustable rate loan.
Which one is right for you?
“At the beginning, lots of consumers are excited about getting a home equity loan or line of credit,” says Thor George, a Southern California loan consultant who has successfully walked hundreds of applicants through the process. “But first, do some homework so you will understand the basic differences between the two loan products, and be aware of the variables that can affect the loan’s approval.”
Some consumers like the stability of the more traditional FIXED RATE LOAN. It’s the most plain and simple loan product available – and it’s considered the “conservative” choice. As its name implies, a fixed rate loan has an interest rate that is fixed for the term of the loan. The payments on the loan are also fixed at one amount. For example, if you take out a 30-year fixed mortgage and the payments are $900 a month, then you are going to pay that $900 per month for the life of the loan.
Other consumers like the flexibility of an ADJUSTABLE RATE LOAN (also known as an adjustable rate mortgage or “ARM”). This is an “aggressive” loan in which the interest rate is adjusted periodically based on a pre-selected index. The time between the interest changes can vary, but it is usually annually.
Adjustable rate loans are attractive because the flexible interest rates can allow borrowers to qualify for loan amounts usually beyond their current financial reach. The interest rate on the amount borrowed can be much lower during the first year (or years) of the loan. That’s what makes it more affordable. But in the following years, the interest rate can fluxuate upward or downward, depending on the index you and your lender have agreed upon. That’s what makes it more risky.
Normally, adjustable rate loans fluxuate within a margin comfortable to most consumers -- perhaps one or two percentage points – and include a “cap” which keeps the rate from going any higher than a predetermined level. But consumers need to keep in mind that any interruption in their income, such as a death, divorce or loss of a job, can push cash-strapped households into troubled waters.
One option for consumers is to use the home equity loan as a line of credit – taking out just what they need, when they need it.
“A home equity credit line can be great in an emergency or to use as an investment vehicle,” George says. “And best of all, you only pay on what you borrow. Later on, consumers also have the option of converting their adjustable rate loan into a fixed loan.”
George also advises consumers to look before they leap. The variables are very important. Potential loan applicants need to make themselves familiar with the loan application process, how their credit history affects whether the loan will be approved, and be prepared to provide the necessary information in a timely manner. If you think a home equity loan is in your future, be aware that everything you do now that involves credit will affect the loan process later. Be careful about changing jobs (particularly changing professions), and think twice about taking out other consumer loans or using existing or new credit cards. All of these could significantly affect your debt-to-income ratio.
Remember, consumers (that’s you) carry the ultimate responsibility for making sure they get the loan that is right for them and understand the financial obligation they are taking on. How do they do that?
1. Do your homework: Know the terms and lender products that are available. The variety is extensive. But don’t let that intimidate you, take advantage of it. Choose the right product so that it works for you and your family’s future.
2. Shop around. Contact different lenders, compare options and choose the home equity loan that best fits your income and needs.
3. Check and re-check. Review all paperwork and contracts thoroughly before you sign or agree to anything.
4. There are no stupid questions: Don’t hesitate to ask questions about the terms and conditions of your financing agreement.
5. If you are considering an adjustable rate loan, it pays to check with several lenders for the lowest rate. Compare the annual percentage rates – and don’t forget about the other charges like points and closing costs.
6. Check out the Federal Trade Commission’s handy web site: www.ftc.gov. The FTC works for you to prevent fraudulent, deceptive and unfair business practices, especially in the lending marketplace.
David W. Johnson is a free lance writer and media consultant based in Southern California. He currently writes real estate finance related articles, you can read more of his articles at http://www.bdnationwidemortgage.com and get more information about home equity loans and second mortgage loans. For a complete look at loans and rates please go to http://www.bdnationwidemortgage.com/equity-mortgage-loan.html “When Your Home is on the Line.” Accessed online at http://www.federalreserve.gov/pubs/HomeLine/default.htm
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