A home equity loan allows the borrower to use the equity in their home to pay down their mortgage or to pay for other major financial expenses, such as college expenses, home remodels, and business ventures. Moreover, home equity loans may be a good choice for homeowners who wish to set up more predictable monthly payments, or lock in payments with a fixed or discounted interest rate. This section provides various resources to help you understand the home equity loan process and options, including in-depth discussion of home equity lines of credit, types of interest rates, closing and continuing costs, and repayment terms and safeguards. Also included are tips to protect yourself when taking out a home equity loan, and how to avoid home equity loan scam artists.
Home Equity Loans and Interest Rates
The main factor affecting the overall cost of a home equity loan is the interest rate, which includes the current prime interest rate and the way in which it is applied to your loan. Some homeowners take advantage of falling interest rates by refinancing (which typically results in a lower monthly payment) and then taking out a home equity loan at that same, lower rate. This is cash that can be used for any purpose, but many homeowners reserve these types of loans and lines of credit for home improvements and maintenance. If you can't afford the payments on your equity loan, even if you need the cash, you should really hold off.
Generally, a borrower can choose among the following loan terms (depending on their credit score and what's available):
- Variable interest rate (works similarly to an adjustable rate mortgage, or "ARM")
- Low introductory rate (these are meant to attract borrowers, but make sure you understand the long-term cost of the loan)
- Fixed rate
The vast majority of home equity loans come with variable interest rates, which are based on the prime interest rate. When the Federal Reserve adjusts this rate, the rate of your loan will follow. A fixed rate may be more desirable if available, but keep in mind that you will pay a premium for a fixed rate equity loan. If you are taking advantage of a discounted introductory rate, make sure you can afford the rate that you will be charged once the introductory period has ended.
Repayment Terms
Home equity loans are not all created equal, and can vary quite a bit with respect to how they're repayed. For instance, some loans have so-called "balloon" payments toward the end of the loan, while others have higher monthly payments in exchange for more-predictable monthly amounts. Your home equity line will specify repayment terms both during the loan and -- if applicable -- at the end of the loan.
If your loan has a variable rate, keep in mind that the rate is subject to change. It may be hard to predict how and when this rate will change, but ask the lender for some general guidelines. And since most people have lean months from time to time, and some may even miss a payment, you will want to understand how penalties for late payments are handled.
At the end of the loan -- depending on the type of loan -- you may owe a relatively large chunk of money. Knowing this ahead of time and planning ahead for that last payment can give you substantial peace of mind. You may be able to renegotiate the terms of the loan if you are concerned, since lenders typically would rather work with you for something that works than push you into default. Another way to protect your interests is to get an agreement (in writing) that any end-of-loan balance be refinanced or paid with an extended repayment deadline.
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