Hitting Up Your Home for a Loan

It wasn’t supposed to be this way. They told us before the contractors started digging the foundation, this was the "starter home." But when the family began to grow, so did home values and remodeling proved easier than finding a decent house to buy.

You’re not alone. Home values are increasing at a record pace across the country, prompting many homeowners to reinvest that newly gained equity back into their homes rather than relocate. But what’s the best way to raise cash for the contractor?

Home equity loans
The practice of borrowing against the value of a home has gained in popularity over the last 10 years. According to the National Home Equity Mortgage Association www.nhema.org, home equity loans will hit $500 billion this year compared to $34 billion ten years ago. There are three key reasons for this surge: escalating home values, low interest and tax deductibility.

There are two ways to tap into the home equity of your home. The right choice for you depends on your needs. If you’re looking for a fixed, lump-sum amount, perhaps for a major home improvement project, you’re better off with a home equity loan. With a home equity loan, the term, and usually the interest rate and monthly payment, remain the same over the life of the loan.

If you want the convenience of drawing against your credit line as the need arises, a home equity line of credit—also known as a HELOC—is more likely to meet your objectives. Instead of borrowing a fixed amount of money, you qualify for a certain amount of credit. You then can borrow up to your credit limit whenever the need arises. The money is accessible instantly, usually by writing checks assigned to the amount or by using a credit card issued by the lender.

Regardless of the route you take, shop lenders to get the best rate and terms. Include the following questions when considering a home equity product and lender:

What am I paying in interest? Interest rates vary among lenders, so query several and compare the annual percentage rate (APR). Remember, the APR is based upon the interest rate alone. For a true comparison of credit costs, compare other charges, such as points, fees, and closing costs. If the lender is offering an introductory "teaser" rate, be sure to find out what rate you will be paying after the promotional period ends.

What is the index based on and how often can it change? The interest rate on a variable-rate loan must be based on a publicly available index. Most lenders use the prime interest rate. In today’s market, you should look for a lender that offers the prime interest rate for the life of your loan. In any case, you shouldn’t have to pay more than two points above prime. It’s also important to know how often the lender adjusts the rate.

How much can the rate increase? Under current law, all variable-rate plans must have a cap on how high your interest rate can climb over the life of the plan. 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.

What are the closing costs? Closing costs, which may include (but are not limited to) a title search, appraisal, attorney fees, recording charges, and notary fees, also vary from lender to lender. With financial institutions vigorously competing for the home equity market, you should be able to negotiate waiving some or all of the closing costs. But shop carefully, as some lenders impose a fee for each time you access the account, and others charge for not using the it.

What are the repayment terms? Usually, you repay the loan in regular installments. Paying more than the minimum monthly payment will pay off the loan faster and reduce your costs. Check your terms, though. Early repayment may have a penalty attached. Unless it is absolutely necessary, avoid interest-only repayment options in which you pay on the interest during the term of the loan and the balance is due at the end of the term. This option can prove much more costly.

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