Depending on the economic climate, banks and other lenders may be chasing after homeowners with cash in their hands, or they may be more conservative. In times when lenders are eager to loan they may waive most or all of the up-front fees. In 2005, a combination of a steady rise in the value
of homes and historically low mortgage interest rates saw many institutions
offering equity loans without any charge to the borrower.
At other times you may be asked to pay fees, including:
• A charge for a professional appraisal of the value of your home.
(If you bought your home not long ago or otherwise have a
recent appraisal, you may be able to have the lender accept that
evaluation.)
• An application fee, which is merely added profit for the lender
for performing the work it is set up to do anyway.
• Points, which is a way for the lender to collect interest up-front;
one point is equal to 1 percent of the amount borrowed or the
credit limit. If you are comparing a loan that requires payment
of points to one that does not, you should see a lower interest
rate if you are prepaying interest.
• Closing costs, including attorney fees, title searches, title
insurance, recording fees at local government offices, and
special mortgage taxes.
The lender will record its interest in the home on deeds or other records
held in your locality to prevent you from selling the home to someone else
before the loan is paid off. You will also have to add the lender as a beneficiary
to your homeowners’ insurance so that they are protected. (Issuers of equity
loans and second mortgages are generally second-in-line behind the primary
mortgage company when it comes to collecting from the insurance company;
the homeowner is last in line behind creditors.)
There may even be some terms of the loan that require you to maintain
the value of the property through scheduled maintenance and repair (which
you should be doing anyway). And some lenders may insist that the home
remain as your principal dwelling; if you move elsewhere and rent out the
property to someone else, the loan may become immediately due.
Some plans are open-ended, meaning that as long as you own the home
and keep current on interest payments, the account is active.
Other equity lines have a fixed “draw period”; at the end of this period—
a typical term is ten years—you will not be able to borrow more money and
must begin paying off the principal as well as the interest.
Another form of equity line of credit calls for the outstanding balance
to be paid off in full at the end of the draw period, while others give the
borrower the right to “renew” the loan at the end of the draw period, although
interest rates and other terms might change.
If the loan requires full repayment at the end of a specific period of
time, you will have to come up with a “balloon payment” from one source or
another. You may be able to take out a new equity loan for the balance; you
may have to take money from other investments you have; or you may be
forced to sell the home to pay the creditor.
Interest Rates on Equity Lines of Credit
Most equity lines use variable interest rates; the agreement between
lender and borrower ties the rate to a published index such as the prime
rate or the U.S. Treasury Bill rate. The rate can be set to exactly mirror the
index, or might be something like “prime minus 1 percent” or “LIBOR plus
2 percent.” (LIBOR is an international index, the London InterBank Offered
Rate, used by some lenders.)
When the interest rate charged is above or below the index rate, the
difference is called the margin.
Some lenders will offer a discounted introductory interest rate for the
first few months or even for a year or more before the rate becomes set by an
index. Variable rate equity lines of credit are required by federal regulations
to have a cap (a ceiling on how high the rate can rise).
And some agreements permit you to change the terms of the loan so that
the interest becomes fixed at a certain rate, usually a point or so higher than
the current variable rate. If you see that interest rates have begun an upward
climb, you should consider locking in a fixed rate if you can.
However the interest rate is structured, be sure you fully understand the
process. If it is variable, find out which index it is tied to. How often can it be
adjusted? What is the cap? Can the loan be converted to a fixed rate?
Read More: How an Equity Line of Credit Works
