Home equity refers to the value of your home minus the amount you owe on your mortgage. You can use this equity to secure a loan, possibly with low interest rates. Depending on your income and credit history, you may be able to borrow up to 85% of your equity, but remember you put your home at risk if you default. Home equity loans can be either:
- A line of credit: A home equity line of credit (HELOC) is an account that you can write checks against, up to a certain amount. These accounts stay open for a certain amount of time, called a draw period, after which you may have a repayment period to repay your principle.
- An installment loan: These loans provide a lump sum payment and are often called second mortgages.
The terms for each loan type can be very different.
Home Equity Loan Interest Rates
Most HELOCs come with variable interest rates, often tied to the prime rate, and some lenders offer special low introductory rates. Second mortgage loans usually have a fixed interest rate. This rate may be higher than for a variable rate loan, but has the advantage of being stable, so you won't have any nasty surprises in the future. Although less common, HELOCs can have a fixed rate and second mortgages variable rates. If you get a variable rate loan, make sure you know: - How often the lender recalculates interest rates - The periodic cap: how much the interest rate can change at one time - The lifetime cap: how high the rate can go over the life of the loan - Whether your initial interest rate is an introductory rate, how long the introductory period lasts, and what your interest rate will be when the introductory period ends
Home equity loans usually have higher interest rates than first mortgage loans, because the lender is taking a little more risk. It gets paid after your original mortgage holder if you default. If you are comparing HELOC and installment loan rates, keep in mind that the annual percentage rate for a line of credit doesn't include points, closing costs or other fees while an installment loan does. Take this into account to make an accurate comparison.
Home Equity Loan Repayment Terms
The draw period on a HELOC is often five to ten years, possibly followed by a ten to twenty year repayment period. Some HELOCs have a balloon payment at the end of the draw period, meaning you have to pay back any remaining principle all at once. Monthly payments on a HELOC depend on how much of the credit line you use, as well as the interest rate, so they change when you withdraw more money or the interest rate changes. During the draw period, your payments may go only toward interest, or they may also cover a portion of the principle. Your HELOC may have minimum or maximum withdrawal requirements and may require repayment in full if you sell your home. If your home's value decreases significantly or your financial situation changes, your lender may have the right to freeze or reduce your HELOC. A second mortgage loan usually has fixed monthly payments lasting for ten to fifteen years.
Closing Costs, Fees and Other Considerations
Most loans come with closing costs, many of which are based on the total loan amount, just like a mortgage. Possible fees include: - Points: a percentage of your loan amount - Application fees - Appraisal fees
Some lenders charge additional fees, often called "continuing costs," for HELOCs. These include: - An annual fee: A charge just for having the account and due even if you don't use it - A transaction fee: Charged each time you withdraw from the account
Under federal credit law, you have three days to reconsider and change your mind about your loan. You will not have access to the money during this time. If you do decide to cancel the contract, you need to do so in writing before midnight on the third business day after signing it and receiving a Truth in Lending notice and disclosure form.