Chris and Richard Paulson thought they had done all the right things in getting their daughter, Aimee, ready for college.
A home equity line of credit is a convenient and flexible way to use the equity in your home as collateral for borrowing. It works almost like a bank credit card, but it has much higher credit limits and much lower interest rates. A home equity line of credit also has many tax benefits. Like any home equity loan, your credit line is based on the equity in your home and your ability to repay. No matter how high your limit is, you pay interest only on the money in use. Once you have established your line of credit, you can draw from it by writing a special check.
Since a home equity line of credit is so easy to use, it is also easy to abuse. The Consumer Bankers Association has devised a list of six tips to consider when using your home equity line of credit. By following these tips, you can make wise use of your home equity.
Your lender isn't the only one who should ask questions. When it comes to a home equity line of credit, the questions you ask are just as important. As with any type of loan, it is essential to understand what you are getting into. Here are just a few of the questions you should ask any lender before making a final decision.
Lenders often charge an up front fee known as points to home equity loans and lines of credit. Each point is equal to 1 percent of the loan amount. For example, on a $25,000 line of credit, one point would be $250.
Points often have impact on your loan's Annual Percentage Rate (APR). When shopping for your home equity loan or line of credit, be sure to compare the APR and not just the contract interest rate. As the following table shows, for example, a loan of 9.5 percent with three points is equal to an APR of 9.85 percent and is, therefore, almost identical to a loan of 9.75 percent with one point (APR 9.87 percent). All lenders are obligated by regulation to disclose a loan's APR. Comparing the APR rather than the contract interest rate of a loan is, therefore, a good basis for comparing the costs of different loans.
Effective Rate on Home Equity Loans (25-year Amortization)*
|Contract Interest Rate||One||Two||Three||Four||Five|
Source: U.S. League of Savings Institutions (now America's Community Bankers)
Applying for a home equity loan or line of credit is similar to applying for any mortgage loan. The lender you choose will need to ask many questions and gather important data before your loan can be approved. You can make the loan-approved process as painless and swift as possible by doing some homework before you apply.
Some of the questions you are asked will seem basic: full name, current address, former address, marital status, number of dependents, and so on.
Other questions may be a bit more personal. Nonetheless, you should be prepared to answer them. Some of the questions you may have to answer include:
The most important consideration for any lender is whether or not you will be able to meet your loan payments. To make a decision, the lender will need certain documentation. Be prepared for the following:
Tapping your home equity makes good sense tax-wise. The Tax Reform Act of 1986 phased out the deductibility of personal loan interest. But, thanks to the 1987 Tax Act, homeowners with home equity loans and lines of credit can still deduct the interest from their federal income tax returns on up to $100,000 of home equity borrowing ($50,000 for married couples filing separate returns). The message is clear: if you're interested in tax savings, your home may be the best bargain around.
Acquisition Indebtedness -- Debt incurred in acquiring or constructing your principal residence or second home plus debt incurred for the purpose of making substantial home improvements.
Annual Percentage Rate (APR) -- The cost of credit consumers pay, expressed as a simple annual percentage. It takes into account interest, points, and the loan origination fee.
Appraisal -- The estimated value of property.
Balloon Payment -- A final payment on installment debt that is much larger than the regular monthly payments.
Debt Consolidation -- Obtaining one loan to repay multiple debts.
Home Equity -- The difference between the current market value of a home and the claims against it.
Index -- A statistical composite used by lenders to establish variable loan rates. An index measures changes in the economy or financial markets.
Lifetime Interest Rate Cap -- An amount, usually given in percentage points, that limits how high or low a variable rate loan can change during the life of the loan.
Line of Credit -- The funds a lender is willing to make available to a borrower. The borrower may use all, a portion of, or none at all.
Points -- An upfront fee charged by many lenders. One point is equal to one percent of the loan principal.
Prime Rate -- The interest rate banks charge to their most creditworthy customers.
Refinance -- Prepaying the balance mortgage by replacing it with a new one.
True of False
||Total monthly payments on all types of loans should not exceed about 45% of your monthly before-tax income.
||A home equity credit line is based on the equity in your home and your ability to repay.
||You usually access your line of credit with a bank credit card.
||The most important consideration for any lender is your ability to meet loan payments.
||Each point charged for your loan is equal to one percent of the loan principal.
||Points have no affect on a loan's Annual Percentage Rate.
||A home equity line of credit is very flexible.
||Interest payments on home equity loans may be fully deductible.
1 False; 2 True; 3 False; 4 True; 5 True; 6 False; 7 True; 8 True
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