NCOA National Council on Aging

Help With Decision Making

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Home Equity Loan Comparison

Use this worksheet from Office of the Comptroller of the Currency to help you ask questions about home equity loans and compare answers from several lenders.

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Key Questions to Consider

What’s the difference between a second mortgage and a home equity line of credit (HELOC)?

A second mortgage, sometimes called a home equity loan (HEL), gives you a lump sum of money with a fixed repayment schedule. This type of loan could be a good choice if you have a home improvement project or if you want to consolidate debt.

A home equity line of credit allows you to get money when you need extra cash and only pay interest on the amount that you borrow. HELOCs make sense if you want a “rainy day” fund or cash to pay for major purchases like a new furnace. Check out the terms of both a home equity loan and a home equity line of credit before making a decision.

How much can I borrow?

Most lenders set a credit limit based on a percentage of the equity in your home. They calculate this based on your home’s appraised value minus the balance of your mortgage.

Lenders typically offer a home equity loan at 80% of your home’s equity. For example, if your home is valued at $100,000, you might qualify for an $80,000 loan minus the balance of your existing mortgage. Experts advise that you keep 20% of your equity untapped as a cushion.

What interest rate will I pay on the loan?

The interest rate on your loan will affect how much you will pay to borrow the money. Shop around to get the best deal. Remember that a lender will review your income, debts, and credit history in deciding on the interest rate and other terms of a home equity loan.

How long can I access money from a home equity loan?

Ten years is a common loan term, after which you may renew the loan. If you decide to sell your home, you must repay the full amount of the equity loan.

How will I repay it?

The payment terms of a home equity loan may be not be the same as your mortgage. Different plans have different monthly payment terms, so review these carefully.

Some plans allow you to apply a portion of the monthly payment to reduce the principal balance. With other types of home equity loans, you will pay a set a minimum monthly interest-only payment during the term of the loan. Interest-only loans require you to pay off all of the remaining loan balance (sometimes called a “balloon payment”) at the end of the term.

Is a home equity line of credit right for me?

If you need cash to fill a short-term financial gap, it might be a good option. Plan to use the borrowed money for only those expenses with long-lasting benefits (home improvement, debt reduction, health care, etc.). If you need extra funds to cover monthly expenses for many years, a reverse mortgage may be a better choice because you will not need to make any monthly payments.

Cost Concerns

What fees will I have to pay?

Similar to a conventional mortgage, you may pay an application fee, an appraisal fee, and closing costs for title searches, title insurance, preparation, filing, and taxes. You may also pay points—one point equals 1% of the credit limit.

What interest rate will I pay?

Because you are pledging your home as collateral, a home equity loan is considered a secured loan and often has a lower interest rate than a credit card, although you can deduct interest payments if you itemize your income taxes.

Many home equity lines of credit have adjustable interest rates, where the annual percentage rate (APR) may change each year based on an index that reflects changes in the economy. Find out which index is being used to calculate the APR and be sure you know the “cap” or highest rate you can be charged. Avoid adjustable rate loans that do not have a cap on the interest you might pay.

Is the line of credit guaranteed?

Since loan policies vary from lender to lender, do not assume that your line of credit will always be available to you. Many lenders reduce the approved loan amount if the value of your home declines or if you have a change in your income.

During a period of economic uncertainty, lenders can freeze or rescind your line of credit without warning, which may, in effect, cancel your line of credit. Review the terms of your loan agreement carefully to avoid surprises.

Do home equity lines of credit have pre-payment penalties?

Pre-payment penalties are fairly standard with home equity loans. You will typically owe a fee if you pay off the loan before the set time referenced in your loan agreement (usually three to five years). These penalties can be as little as $100 or as much as 3% of your original loan amount.

What is a “non-usage” fee?

A lender expects that you make regular use of the funds available in your home equity loan account and may charge an inactivity fee if you do not use your line of credit over a given period of time. Be sure you are aware of the fees a lender may charge for a home equity line of credit.

Consumer Cautions

What is the biggest risk of a home equity line of credit?

When you use the equity in your home for a loan, the lender will place a lien on your property, so losing your home is a possibility if you fail to pay back the money you have borrowed.

In some states, a second mortgage such as a home equity loan may be a recourse loan. This means that the lender can also use a range of legal means to collect the outstanding debt that you fail to pay, including garnishing your wages and placing a levy on your bank account. Check this List to see whether a home equity loan in your state is a recourse loan.

What should I watch for with interest rates?

Be wary of a low introductory rate that can make a loan seem very affordable but is different from the APR in your loan agreement. A lender might offer a temporary discounted interest rate as an “introductory rate” that may be lower than the stated APR but then increases at the end of six months.

Can I rent out my house if I have a home equity line of credit?

Some lenders require that you live in your home as your primary residence. In these situations, you will not be able to rent it out. Review your loan agreement carefully. In other cases, you may be able to rent out part of your home if you continue to live there.

What if I change my mind after taking out a home equity loan?

If your home is your primary residence, the Truth in Lending Act gives you three days to change your mind for any reason after taking out a home equity loan. Once you inform the lender in writing during the first three days, the lender must refund all fees—including the application and appraisal fees.

I get a lot of offers for financial products. What are some danger signs that can help me to avoid scams?

Whether you are considering a home equity line of credit, reverse mortgage, refinancing, or investing some of your hard-earned cash, unscrupulous marketers may appear on your doorstep or through your networking groups.  The U.S. Securities and Exchange Commission offers advice to seniors on how to avoid investment fraud and scams.

How can I avoid going further into debt?

Remember that you cannot get out of debt by taking on more debt. You need to make a budget and be disciplined about how you spend your money.

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