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Understanding the Home Equity Loan

A home equity loan can be handy when it comes time to finance a major life expense like home remodeling, a child’s college education, or maybe even purchasing an investment property. This is the time when you get to reap the benefits of all those years paying a monthly mortgage. In simple terms, this type of loan allows you to borrow against your home, using the capital you have sitting in it as collateral. As with any other type of loan, banks have stringent lending procedures, but if you’ve been tending properly to your credit score and other areas of your financial life, there’s a good chance you can tap into this accumulated wealth.

Dissecting the Home Equity Loan

Sometimes people have a hard time wrapping their head around the idea of using money already spent as collateral. It might help to think of your house as a giant piggy bank. Each month, part of your mortgage payment goes to cover interest on the loan but part of it is principal, which counts against the buying price of the house.

Say you agreed to pay $100,000 on a 20-year mortgage. By the time 15 years have passed, you may have paid the actual principal owed down to $20,000. In this case that means you have $80,000 of what is called equity sitting in your house. A caveat: you might actually be able to borrow more than $80,000 if your house has gone up in value. Assuming your credit score is good, a bank would normally agree to make a home equity loan on 85 percent of the value of your equity.

Home Equity Loan Rates

When it comes to choosing this type of loan, it’s all about finding the best home equity loan rates you can. Here’s where you need to shop around. For reasons the average customer may never comprehend, rates can vary greatly from one institution to the next. Maybe one bank has a big, fat chunk of money to lend and just wants to get it out into the market. Check rates with local banks, credit unions, savings and loans, and mortgage companies.

Your basic choice when it comes to interest rates are between fixed and variable. Your lender may offer both. The thing to keep in mind is that many people prefer home equity loan fixed rates, which are exactly what the name implies. Your interest rate is fixed for the life of the loan. It won’t go up or down. Variable rates are tied to the prime interest rate which is set by the Fed chairman. If the prime rate goes up, it takes your interest rate with it. Same thing if it goes down. The uncertainty of variable rates scares some people.

Points to Ponder

When it comes time to scratch your signature on the contract at close, don’t do it unless you understand absolutely everything associated with the loan. Know the terms and conditions. Understand all the applicable fees because there will likely be a bunch of them: loan processing fee; underwriting fee; lender’s fee; appraisal fee; document preparation and recording fee; broker fees – and the list goes on. The big picture to keep in mind is that the more fees you fold into the loan amount, the more you’ll pay to finance them. You may prefer to pay for them outright up front.

The final point we’d like to make is that you should never sign a contract unless you’re completely at ease with the terms. It’s normal to have butterflies in your stomach any time you close on such a high value deal, but if you have a sick feeling like you’re getting shafted, either negotiate until you feel comfortable or walk away! Also keep in mind the three-day-cancellation rule, which applies in most instances. You can change your mind within that time frame for any or no reason at all and void a signed contract.

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