Home Equity Borrowing
If you need to borrow, a home equity loan
usually offers the best rates, plus the advantage of tax savings.
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Home
equity loans let you borrow using the equity you've built up in your home
as collateral. You can often borrow more money at a lower interest
rate than with other types of loans. And, in many cases, you can deduct
the interest you pay on the loan when you file your tax return, reducing
the actual cost of borrowing still further. Most of the other interest you
pay, on car loans or personal loans, for example, isn't deductible. You
can choose between:
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ATTRACTIONS
- They are easy to arrange
- The rates are usually lower than on unsecured loans
- The interest is tax deductible, though
there may be a cap and other restrictions (check with your
tax adviser)
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DANGERS
- You risk losing your home if you default on the payments
- Even if the value of your house decreases, the amount of your loan stays the same
- You may have to pay high closing costs
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HOME
EQUITY LOANS With a home equity loan, you borrow a lump sum, usually
at a variable rate of interest although some fixed-rate loans are available.
You pay off the debt in installments, in the same way you repay your mortgage,
with some of each payment going toward the interest you owe and the rest
toward the principal, or loan amount. At the conclusion of the payment period,
the loan is retired.
You may have to pay closing costs on your loan, just as you did for your
first, or primary, mortgage. But lenders may offer loans with no up-front
expenses as part of a promotional deal. You might also be offered a teaser
rate, or a period of low interest as an incentive to borrow. If that's
the case, the lender has to tell you the actual cost, or annual percentage
rate (APR), and when the temporary rate ends.
HOME EQUITY LINES OF
CREDIT Home equity lines of credit are actually revolving
credit arrangements, which you can use in much the same way you use a credit
card. Your credit line, or limit, is fixed, and you can write a check
for any amount up to that limit. Whatever you borrow reduces what's available
until you repay. Then you can use the repaid amount again.
The terms of repayment vary with the loan and are spelled out in your agreement.
In some cases you begin to repay principal and interest as soon as you borrow,
or activate the line. In others, you pay interest only, with a balloon, or one-time full payment of principal at some set date. Or, you may make
interest-only payments for a specific period, and then begin to pay principal
as well.
Most credit lines have an access period, often five to ten years, during
which you can borrow, and a longer payback period. The longer you take to
repay, the more expensive it is to borrow.
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WHAT
YOU CAN BORROW As a general rule,
you can borrow up to 80% of your equity in your home with a home equity
loan. For example, if you had a $75,000 mortgage on a home appraised at
$250,000, your equity would be $175,000. In most cases, you'd be able
to borrow up to $140,000, or 80% of $175,000.
Some home equity lines of credit, especially those offered without closing
costs or other up-front expenses are capped at a fixed amount, such as
$50,000. Each time you use your line of credit, your equity is reduced
by the amount you owe. When it's paid off, your equity is restored. However,
if your home loses some of its value during the loan period, you still
owe the full amount you borrowed.
BEWARE
THE RISKWhile home equity
borrowing has a lot of advantages, it has one serious drawback: If you default, or fall behind on repayment, you could lose your home
through foreclosure. That means the lender has the right to take
over the property. That's true even if you've made all the payments on
your first, or primary, mortgage.
That risk is the chief argument
against using home equity borrowing — lines of credit in particular
— to pay day-to-day expenses. If you're using the money to make improvements
in your home, pay tuition bills, or meet other major expenses, and include
loan repayment as a regular item in your budget, home equity borrowing
can be a wise choice. But if you're in the position of not being able
to repay, you're exposing yourself to losing everything you've invested
in your home — and having no place to live.
FINDING A LOAN Home equity
loans are generally easy to find. Banks offer them, and so do credit unions,
mortgage bankers, brokerage houses, and insurance companies.
You can start by checking rates and terms advertised in the newspaper
and making some phone calls to see what's available. But before you commit
yourself, you should get a description — in writing — of the
specific rate, term, and other conditions of the loan you have decided
to take.
SETTING THE RATE Each lender sets the terms and conditions of loans
it makes, though the basic elements are usually similar. If a home equity
line of credit has a variable rate, it must be tied, or pegged, to a specific
public index, often the prime rate, rather than to some internal index
that the bank controls. Most home equity installment loan rates are also
tied to an index, though federal law doesn't require it for this type
of loan.
The lender adds a margin, expressed as basis points, or
hundredths of a percentage point, to the index to determine the new rate
each time it's adjusted. It may happen once a year or sometimes more often.
REVERSE MORTGAGESFor older people with lots of equity but limited
income, a reverse mortgage may be an appealing alternative to selling
their homes or depending on family members to meet their bills. A reverse
mortgage allows owners to borrow against the value of their home, either
by getting a regular monthly check (either for a fixed term or for as
long as they live in the home), a line of credit, or some combination.
You can arrange for reverse mortgages through individual lenders, the
Home Equity Conversion Mortgage program of the Federal Housing Administration
(FHA), or Fannie Mae. The amount you can borrow depends on your home's
market value, your age, and the cost of the loan. In addition, some lenders
impose caps on the amount they will lend.
While interest rates quoted on reverse mortgages can be similar to those
for other mortgages, there are additional fees and charges that can make
them more expensive than other types of loans. Lenders must provide a Total Annual Loan Cost disclosure form that estimates the average
annual cost as an interest rate, or percentage of the loan.
As competition among lenders grows, borrowers
may be able to arrange better deals on reverse mortgages. But many people have
serious reservations about the wisdom of borrowing in this way. |
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© 2006 by Lightbulb Press, Inc.
All Rights Reserved.
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