ABOUT HOME EQUITY LOANS

What is equity and how can I use it?

Equity is the difference between your home's appraised value and the balance of all of your mortgage loans. The equity you've built up in your home can work to your advantage if you'd like to borrow cash for major purchases. By using the equity in your home, you may qualify for a sizable amount of credit, available for use when and how you please.
In general, interest rates for home equity loans and lines of credit are usually lower than what you'd expect to pay on a credit card - because your home serves as collateral, the lender's risk is lower. Some benefits of using your home equity:

  1. Offers tax advantages. In many instances, the interest paid on a home equity loan or line of credit may be tax deductible.
  2. Provides a new source of capital. A home equity loan is a way to finance college educations, make home improvements or buy a new car.
  3. Helps build home equity. Investing the money in home improvements may help to build equity while borrowing against it.

Assuming that a home-equity loan is always cheaper than a car loan or a credit card, a credit card at 6.9% is cheaper than a credit line at 12% even after the tax deduction. To compare rates, compute the effective rate of your home-equity loan, with the rate on a credit card or auto loan.

Effective rate = rate x (1 - tax_bracket)
Example : If the rate of the home-equity loan is 12% (0.12) and your tax bracket is 30% (0.3), your effective rate is :
12%(0.12) x [1-0.3] = 12%(0.12) x 0.7 = 8.4%

If your credit card is higher than 8.4%, then the equity loan is cheaper, otherwise it is not. Be sure to also compare monthly payments and other terms of the loan, don't judge on the interest rate alone.

When should I use my home equity?

Among the most popular ways to use home equity:

  1. Debt consolidation - Pay-off one or more higher-priced loans.
  2. Emergencies - Pay medical bills or deal with other emergencies.
  3. Education - Pay for education costs.
  4. Home purchase - Use the equity you have in one home to buy another home.
  5. Home improvement - Remodel a kitchen, build a swimming pool or build an addition on your house.
  6. Auto purchase - Purchase a car and reap the possible tax benefits.

11 Steps to get a Home Equity Loan

Using the equity in your home, may qualify you for a sizable amount of credit, to use when and how you please. The following short list will help you stay on course getting a home equity loan or equity line of credit.

1. Shop around
You should always look around to see who can offer you the best program available to you before making a commitment.

2. Understand the difference between a loan and a line of credit
An equity loan is closed--you get all your money up front, then make fixed payments on that loan until you pay it off. An equity line is open--you get an initial advance against the line and then reuse the line as often as you need during the period that the line is open. Most equity lines are accessed through a checkbook or a credit card. For both equity loans and lines, you can only be charged interest on the outstanding principal balance.

3. First check out the tax consequences
Most borrowers can use their interest paid on home equity loans as write-offs but in some instances, your home-equity loan is NOT tax deductible. Perhaps you make too much and fall into the AMT trap, or perhaps you have pulled out more than $100,000 cash from your home. It's best to check with your CPA or accountant regarding the specific tax implications on your loan.

4. Know the specifics of your loan
Know if your loan has a pre-payment penalty, it will lower the fees on obtaining a credit line, but it will only affect some. If you are getting a "no fee" home equity loan, chances are that it has a hefty pre-payment penalty clause included in the loan. If you plan on selling or paying the loan off soon, then this is something you will want to avoid.

Know the lifecap on your equity loan, many credit lines have lifecaps of 18 percent. Be prepared to make payments at higher interest levels if rates move upwards.

5. Check out other loan/refinance options
Consider a cash-out refinance instead of a home equity line of credit, sometimes it might be more beneficial depending on your current situation. You should discuss the two options with your loan officer to see which will work better for you.

6. Plan your financing
If you are planning to refinance your first mortgage in the near future, consider that many mortgage companies look at the combined loan amounts (i.e. the first loan plus the second) even when they are refinancing the first mortgage. Check with your mortgage company to find out if getting a second will cause your refinance to be turned down.

7. Watch the size of your credit line
Too large a credit line can get you turned down for other loans. Some lenders calculate your payments based on the available credit, not the credit used. Even when your equity line has a zero balance, having a large equity line indicates a large potential payment, which can make it difficult to qualify for other loans.

8. Be in control of your finances
It is wise to get a home-equity loan to pay-off current credit card debt, but if your spending is out of control, you must regain your financial balance. Be responsible, when you pay off your credit cards with your equity line, don't go out and charge up those credit cards again. If you have trouble putting the financial brakes on the plastic, tear it up!

9. Get everything in writing
Do not expect verbal agreements to be enforceable, a written contract will override the verbal contract. More importantly, your state may require that contracts for the sale of real property be in writing.

10. Don't sign anything without reading it
Review in advance, whenever possible, any documents you'll be signing. Many of the documents you'll sign are standard forms and are usually available for review (even though specifics of your loan may be unknown early in the transaction). You'll have insufficient time to read all the documents during the closing appointment.

11. Know your rights
The Equal Credit Opportunity Act (ECOA) provides for equal access to credit regardless of:

There are additional protections if you have a physical or mental disability.

The ECOA also requires that you are notified within 30 days of the completed loan application that your application has been approved as requested, modified, or rejected. Specific reasons for rejection must be given, in writing, to you at the time of rejection or upon your written request for the reasons.

Real Estate Settlement Procedures Act (RESPA) requires lenders to give you advance notice of estimated closing costs in purchase and refinance transactions.

Truth-in-Lending Act
The Truth-in-Lending Act requires all lenders to fully disclose, iwithin three business days after receiving your loan application, a written statement of fees, terms and conditions associated with a loan including the Annual Percentage Rate (APR), which reflects the cost of obtaining credit.