Since not all home equity loans are created equal, you might find it frustrating when you consider your options. Make your life easier by taking a logical, organized approached to home equity loan shopping.
In Alfred Hitchcock's movie, The 39 Steps, a man is caught in a web of intrigue that complicates his life and causes it to spin out of control. To avoid being caught in a similar circumstance when shopping for the best home equity loan you can find, here are six steps that will keep things simple and easy:
1. Shop around for the best deal
Start with your existing bank or credit union. But don't stop there – check out a number of other lenders as well in order to find the best home equity loan rates. You may also consider gathering bids online or responding to advertisements. Just remember to be skeptical about promises that sound too good to be true.
2. Know the product
Home equity loans come in two flavors: the standard home equity loan and the home equity line of credit (HELOC). Know the basics of each so that you can assess which one is right for you.
With a standard home equity loan, you receive a certain amount of cash and then repay it on a set schedule, usually at a fixed interest rate. A HELOC works like a credit card, in which you're allowed to borrow as you wish up to a certain limit. HELOCs are adjustable-rate, interest-only loans during the time you can borrow, called the draw, and then usually convert to a fixed-rate loan when the time comes to begin repaying the principle.
3. Know your equity
The amount you can borrow will be determined by how much home equity you have – that is, how much of your current home value is paid for. For example, if your home is worth $400,000 and you owe $100,000 on your mortgage, you have 75 percent equity in your home. Lenders typically want you to have at least 20 percent equity remaining after you take out a home equity loan.
4. Ask questions
Obtain a firm understanding of the points, APR, and closing costs associated with the loans you're considering. These items are detailed on the Good Faith Estimate, a document that the lender must provide within three days of receiving your loan application. One point to note when comparing your options: The APR for a home equity loan includes closing costs, while the APR for a HELOC does not.
5. Choose a rate structure
Home equity loan rates can either be adjustable or fixed. The interest rate on adjustable loans can fluctuate, exposing you to the risk of increasing costs.
Fixed-rate home equity loans have less risk, but can sometimes cost more for homeowners who end up selling in a few years. If you're uncertain how long you'll keep the property, consider asking your lender about a hybrid adjustable loan with a fixed introductory rate.
6. Know your closing costs
The Good Faith Estimate includes a quote on closing costs. Unfortunately, the actual costs at closing are often different from those on the estimate. Most of the fees are assessed by third parties, and therefore not under your lender's control. Ask your lender how closing cost changes are handled.
Home equity loan shopping shouldn't be shrouded in suspense. Follow the steps and make your way to equity financing success.