An equity loan will cost you twice. First, you
pay fees and closing costs, and then you pay interest.
Fees and closing costs
The fees that you pay for opening an equity account
are similar to the ones you pay when you buy a home. The fees can
total 2 percent to 5 percent of the loan and are for such things as:
A home equity loan almost always carries fees and closing costs.
Many lenders don't charge fees or closing costs on credit lines.
If your lender does charge fees to open a credit line, don't rule
out that offer immediately; maybe there are other features that
make it a good deal. But shop around.
||attorney or title agent; and
The most common fee levied on a credit line is for
an appraisal or other estimate of the property's value. Sometimes,
instead of paying an appraiser to visit the house and compare it
to other nearby homes of similar value, the lender accepts a computerized
estimate called an automated valuation model, or AVM. Or a real
estate agent might estimate the value in what is called a broker's
price opinion, or BPO. AVMs and BPOs cost less than full appraisals.
Other fees and interest
The biggest cost you will pay on an equity loan or a credit line
is the interest. Home equity loans usually have fixed rates, and
credit lines usually have variable rates. If you get an equity loan
on the same day that your neighbor gets a home equity line of credit
(HELOC), your rate will be higher than your neighbor's. Over time,
your neighbor's HELOC rate can rise higher than what you pay on
the equity loan, but your rate never changes.
Some lenders offer "teaser" rates that are
artificially low for a few months, then adjust to normal levels.
The variable rate of a HELOC moves up and down with another rate,
called an index.
Most banks index HELOC rates to the prime rate or the prevailing
yields on Treasury notes.
The lender adds a margin, or fixed number of percentage
points, to the index to determine the new rate each time it is adjusted.
For example, a HELOC might use the prime rate as an index, with
a margin of 1 percentage point. If the prime rate is 3 percent,
the HELOC's rate is 4 percent (the 3 percent prime plus 1 percent
margin). If prime rises to 3.5 percent, the HELOC's rate will rise
to 4.5 percent. Adjustments can be made monthly, quarterly or annually.
Variable-rate loans have a cap on how high the interest
can climb over the life of the loan. Most variable-rate lines of
credit also have a cap that limits how much, and how often, the
interest rate can change during the course of a year. This cap typically
prevents the rate from jumping more than two percentage points in
a year. Some plans require a minimum monthly payment. Chart out
how high your payments would be at different rates by going to Bankrate.com's
or ask your banker to do it for you.
Credit lines sometimes have other fees attached to
them, such as annual maintenance charges, transaction fees each
time you use the account, or inactivity fees if you don't use the
account. Both types of equity debt may be subject to prepayment
penalties, which are charged if you pay off or close the account
within two or three years.
If you expect to sell the house within a couple of
years, don't get an equity account with a prepayment penalty.
||Check out rates in
survey of home equity rates and compare.
||Ask the lender what
the lifetime and periodic caps are.
||Find out if there
is a minimum payment.
||Understand what index
is used, what the margin is, and how often the lender adjusts
||Ask whether there is a balloon
payment -- a requirement that the entire balance is due
in a lump-sum payment after a few years.
Understand that you cannot compare the annual percentage
rate -- the cost of the loan each year, expressed as a percentage
-- of a home equity loan against a home equity line of credit. They
are calculated differently. The APR for a fixed-term equity loan
takes into account the interest rate plus points and other finance
charges. For a line of credit, the APR is based on the periodic
interest rate and does not include points and other costs.
Electronic payments sometimes get you a fractional
break on interest rates. Before you sign, consult a tax adviser
about deductions on your loan because there are exceptions to deductibility.