Considering a Home Equity Line? What You Need to Know
A form of revolving credit where your home serves as collateral, home equity loans must be carefully considered, especially in today’s market, to make sure the benefits outweigh the costs. Therefore, before applying for a home equity loan, discuss the idea with your real estate agent and review the following considerations from the Federal Reserve Board. While an equity line can be a great way to fund a college tuition or pay off a big debt, such as medical bills, it can also put your home on the line should you find yourself unable to repay.
Home equity lines of credit typically involve variable rather than fixed interest rates. In such cases, the interest rate you pay for the line of credit will change, mirroring changes in the value of the index. Because the cost of borrowing is tied directly to the value of the index, it is important to find out which index is used, how often the value of the index changes, and how high it has risen in the past. See if your lender will allow you to convert from a variable interest rate to a fixed rate during the life of the plan, or let you convert all or a portion of your line to a fixed-term installment loan.
Fees and Costs
Many of the costs associated with setting up a home equity line of credit are similar to those you pay when you buy a home, such as: paying for an appraisal; an application fee; up-front charges, such as one or more “points;” closing costs, including fees for attorneys, title search, mortgage preparation and filing, property and title insurance, and taxes. Make sure the investment you make to establish the home equity line isn’t more than the amount you actually draw against the line—otherwise, the initial charges would substantially increase the cost of the funds borrowed.
Before taking out an equity line, create a realistic plan for paying it back. Some plans set a minimum monthly payment that includes a portion of the principal (the amount you borrow) plus accrued interest. But, unlike typical installment loan agreements, the portion of your payment that goes toward principal may not be enough to repay the principal by the end of the term. Other plans may allow payment of interest only during the life of the plan, which means that you pay nothing toward the principal. If you borrow $10,000, you will owe that amount when the payment plan ends. Whatever your payment arrangements are, when the plan ends, you may have to pay the entire balance all at once.
Selling or Renting?
If you sell your home, you will probably be required to pay off your home equity line in full immediately. If you are likely to sell your home in the near future, consider whether it makes sense to pay the up-front costs of setting up a line of credit. Also keep in mind that renting your home may be prohibited under the terms of your agreement.
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