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Pre-Payment
Penalties
Check to see if your
loan has a pre-payment penalty clause.
If you are getting a "NO FEE"
home equity loan, chances are that it has a hefty pre-payment penalty clause. This can be
very important if you are planning to sell your house or refinance in the next 3-5 years.
Equity Loan vs.
Equity Line
Be sure to understand
the difference between an equity loan and an equity line.
An
equity loan is closed. The borrower gets all the money up front and then makes fixed payments on
that loan, until it is paid off. An equity line is open, the borrower gets an initial advance
against the line and then reuses the line as needed during the
period that the line is open. Most equity lines are accessed through a
checkbook or a credit card. On equity lines, you only pay interest on the outstanding
balance.
Use an equity loan when you need all the money up front e.g. home improvement,
debt consolidation. Use an equity line if
you have an ongoing need for money or need the money for a future event e.g. you need to
pay for your child's college tuition in 3 years.
LifeCaps
Check the lifecap on your equity line.
Many credit lines have
lifecaps of 18%. Be prepared to pay payments at higher interest levels if rates move
upwards.
Shopping
Around for a Lender
Shop
around, don't just get a home equity loan from your local
bank without investigating other options.
Many consumers get their equity line from the bank
that they have a checking account with. Consider your bank, but also shop around
with other lenders.
Good
Faith Estimates
Get
a good faith estimate of closing
costs.
Your mortgage company is required to provide you with a written good faith
estimate of closing costs within 3 working days of receiving the application.
In some instances your home equity loan is NOT tax deductible. Some reasons for this may
be:
-
your income is too
high causing you to fall into the AMT trap
-
you have taken more than $100,000
cash from your home
Do not depend on your mortgage company regarding this matter - check
with an accountant or CPA.
When
is an Equity Loan the Right Thing to do?
Don't
assume that home equity
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 * (1 - tax bracket)
Example: If the rate of the home equity loan is 12% and your tax bracket is 30% your
effective rate is:
12% * (1-0.3) = 12%*0.7 = 8.4%
If your credit card is higher than 8.4% then the equity loan is cheaper, otherwise it is
not.
Besides the interest rate, you may also want to compare monthly payments and other terms
of the loan.
Don't
get a home equity line of
credit if you plan to refinance your first mortgage in the near future.
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. If you plan on refinancing your
first mortgage,
check with your mortgage company to see if getting a second mortgage will cause your
refinance to get
turned down.
Don't get a larger credit line than you need.
If your credit line is too large it can cause you to be turned
down for other loans. This is due to the fact that some lenders calculate your payments based on the available
credit and not just the used credit. Having a large equity line indicates a large
potential payment, which makes it difficult to qualify for loans.
Note: this situation applies even if you equity line has a zero balance.
Be cautious when getting a home equity line to pay off your credit cards.
If your spending is out of control, understand that the problem is not with the
type of loan you have, it is with your spending. Be careful that when you pay off your credit cards with
the equity line, you don't go out and charge
up those credit cards up again. Doing this will put your house in danger! If you can't manage the
plastic tear it up!
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