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Don't even think about applying for a home equity loan until you know enough about them to make an educated decision. Interest Rates - Before you apply for a home equity loan, you must understand the real meaning of the interest rate you are quoted. The Annual Percentage Rate (APR in banking lingo) is the key. Typically, the lender will give you an attractive introductory rate (a discounted rate) on a home equity loan to lure you in for the loan, but that rate only applies for six months or so, and then most home equity loan rates default to a variable rate that is dependent on the prime rate dictated by the Federal Reserve Bank. Find out what the 'ceiling' is on the interest rate for that loan (in other words what is the maximum the loan interest rate can increase on this loan over its life time?), and be sure you can handle payments at that rate before you sign on the dotted line. Don't make the mistake of comparing the interest rate for a home equity 'line of credit' to the interest rate for a home equity 'loan'. These are structured differently. You CAN, however, compare the interest rate of one home equity loan against another home equity loan, and draw some conclusions from that comparison. Just be sure you comparing 'apples to apples'. If the term of one loan is different than the term of another loan you can't compare the two equally. Total Cost of the Loan - You can't look at the interest rate or APR alone because that doesn't offer a complete picture. When you close on a home equity loan you have to consider closing fees and points on the total loan amount. To close on this loan, you will have to pay a property appraisal fee so that the bank can estimate the value of your house or condo and determine how much money they will lend you. You will also have to pay an application fee to some banks, and points on the loan (one or more points as a percentage of the credit limit), and possibly title search fees, and attorneys fees depending on the size of the loan and the state in which you apply for the loan. In addition, some banks charge a transaction fee every time you draw down on your line of credit (this applies only if you have a home equity line of credit instead of a home equity loan). Structure of the Loan - Find out if your loan includes balloon payments. It is all well and good to know that you can make the maximum monthly payments, but if the loan has a balloon payment at the end, where you have to pay a large lump sum at the end of the term to pay off the unpaid balance, you may not be prepared to make that payment all at once, and that can be a problem. Balloon payments often result from a home equity loan structure where you only pay the interest on the loan amount throughout the life of the loan. This is great for the life of the loan. But, at the end of the term when you have to pay the full principal (which can amount to $20,000, $50,000 or more), it may not be so great! Typically, the lender can offer you a better interest rate on this loan over the loan life and that looks attractive, but the unfortunate surprise comes at the end of the loan when you have to pay off the entire principal in one balloon payment. In addition to balloon payments, you need to look at the loan-to-value ratio of this loan. Before you panic, we aren't going to give you a lesson in high finance. Loan-to-value (LTVR) simply means the percentage of the total value of your home that your bank will lend you. Most banks used to limit an LTVR of 80%, so if your home value was $100,000, they would only loan you $80,000. But today, some home equity loans allow you to borrow 100% OR MORE of your home value. Again, this may sound like a good deal, but it is not. These loans are more expensive (higher interest rates) and you lose a significant tax write-off because you can only write off loan payments on the VALUE of your home - not payments that exceed the value of your home. Additionally, if you sell your home for its appraised value, you will owe more money on the loan than the proceeds of your home sale will give you. Where are you going to come up with that extra money to pay off the loan? If you take a home equity loan that exceeds the value of your home, you will also have to take out insurance on that loan and that will cost even more money. Stick to loans that do not exceed the recommended limits (70% to 80% of the value of your home, including any outstanding mortgage you may have to pay off when you sell your home) and you will be better off. If you are careful to research and compare banks and loan structures to ensure that you understand ALL charges, and that you avoid balloon payments and overblown loan-to-value ratios, you will protect yourself from unpleasant surprises.
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