October 18th, 2019 7:57 AM by Jackie A. Graves
If you’re looking to make home improvements, pay for your kid’s
college education or pay down credit card debt, a home equity loan or line of
credit can be a cheap way to borrow money. The average cost of a fixed-rate
home equity loan is 5.87%, according to our most recent survey of major
A home equity loan requires you to borrow a lump sum all at once
and requires you to make the same monthly payment each month until the debt is
retired, much like your primary fixed-rate mortgage. It’s always been a better
choice if you want to borrow a specific amount for a big one-time project and
you want the security of knowing that your interest rate will never change.
HELOCs allow homeowners to borrow against the equity in their
homes on an as-needed basis. You pay interest only on what you borrow, and the
average HELOC currently costs 6.75%.
But these are adjustable-rate loans based on the prime rate —
the floating interest rate banks charge their best commercial customers — plus
an additional fixed rate. They were incredibly cheap for about eight
years while the prime remained at a six-decade low of 3.25%.
But when the Federal Reserve started pushing interest rates
higher in December 2015, virtually every bank immediately added a quarter of a
point to their prime rate, raising it to 3.50% APY. Now it stands at 5.50%. So
if a bank currently offers you a HELOC at 6.75%, it’s charging you prime plus a
fixed 1.25 percentage points.
Whether you choose a home
equity loan or a HELOC, you’ll qualify for the best rates and
biggest loans with a credit score of at least 740.
With property values rising across much of the country, only
about 4.1% of homeowners with a mortgage remains underwater, according to
Corelogic, owing more on their loans than their property is worth.
That means many borrowers who didn’t have enough equity in their
homes to qualify for a second mortgage have a better chance of being approved.
Lenders require that borrowers maintain 10% to 20% of their
equity after taking the loan or line into account.
To figure out how much you can borrow, subtract the balance you
owe on your mortgage from what your home is currently worth.
If, for example, your home is worth $200,000 and you owe
$140,000 on your first mortgage, you’d have 30% equity, or $60,000.
If the lender required you to retain 20% of your home’s value,
or $40,000, your home equity loan or HELOC would allow you to borrow a maximum
You can borrow as little as $5,000 through some credit unions
and regional banks, but many lenders won’t extend a loan with a limit of less
than $10,000 or even $25,000.
Another recent change is that some of the nation’s biggest
lenders have stopped offering home equity loans. Instead, they’re offering home
equity lines of credit with the option to take a fixed-rate advance on part or
all of your credit line. That means you can combine the advantages of both
types of loans.
Many lenders are offering home equity loans and HELOCs with no
closing costs. The only catch is that if you close your account early — usually
within the first 24 or 36 months — you’ll have to reimburse the lender for
Besides the interest and early-closure costs, you might have to
pay an appraisal fee and an annual fee. Some lenders waive these fees or offer
interest rate discounts if you have other products, like a checking account, at
the same institution.
Make sure you know exactly which fees your bank or mortgage
company is charging, and how much they are, before committing to any loan or
line of credit.
Dodging these pitfalls will make you a happier home buyer now
and more satisfied homeowner down the road. You’ll know that you got the best
possible mortgage and won’t be overwhelmed by unexpected costs.
It’s also important to understand exactly how these loans work
and how the minimum monthly payments will be calculated. Your home acts as
collateral for this type of borrowing, and if you default on your payments, you
could lose your residence.
A HELOC only allows you to tap the line of credit and borrow
funds during what’s called the “draw period” over the first five or 10 years of
While the credit line is open, the minimum monthly payment only
covers the interest charge on the outstanding balance. Some lenders let you pay
1% or 2% of what you’ve borrowed as an alternative to interest-only payments.
In the sixth or 11th year of the loan, the line of credit is
closed and a new fixed monthly payment forces you to begin repaying however
much you’ve borrowed — or in lender-speak, the principal — plus interest over
the next 15 to 20 years.
Experian, one of the three major credit-reporting agencies,
estimates the typical monthly payment increases almost 70% when HELOCs reach
that point. Our line
of credit calculator can help you do the math and determine how
long it might take to pay off your credit line.
It’s also important to know that lenders can freeze or reduce
your line of credit if your home drops in value or your financial situation
changes. That credit may not be available when you need it.
With a home equity loan, you only get one shot at borrowing:
when your loan closes. You’ll have to apply for a new loan or line if you want
to borrow again. But you are guaranteed that initial sum.
The interest for both HELOCs and home equity loans is generally
tax-deductible if you itemize your deductions on Schedule A and if your home
equity loan balance is $100,000 or less all year.
For most homeowners seeking to borrow from their equity, a home
equity loan is a lower-risk option than a HELOC, which in today’s market looks
likely to become more expensive.
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