Home Equity Loans With A Twist

Written by Steve R. Lowry    Thursday, 22 January 2009

Banks are slicing and dicing them so many ways these days that even veteran borrowers should give them a fresh look. GETTING A HOME EQUITY LOAN has never been easier: The hardest part may be choosing among the exploding array of products designed to put borrowed money in your pocket. Bankers who want to capture more of this highly profitable business are churning ont all sorts of deals: superflexible lines of credit that you can carve into mini fixed rate loans; fixed rate loans you can adjust if market interest rates go down: lines of credit that serve as overdraft protection on your checking account. There are even deals that let you tap up to 100% of your home's equity, instead of capping the loan at the traditional 75% or 80%. All of these bells and whistles for the kind of debt that's already the cheapest ere(lit available and tax deductible to boot. Even without the tax break, interest rates on home equity debt hover between one and three points above the prime rate (recently 8.75%), producing a rate of between 9.75% and 11.75%. That's well below the 16% to 18% or so you'd pay on an unsecured loan or credit card debt. Throw in a teaser rate of 4% to 7% for the first six months, plus a federal (and usually a state) tax deduction for your interest payments, and you'd be hard pressed to borrow for less. The first thing you need to decide is whether to apply for a line of credit you can tap at will or a fixed rate loan with fixed payments. Your choice will depend on your plans for the money. A fixed rate loan is akin to a second mortgage, with which you borrow a set amount and repay it in fixed monthly installments over ten to 15 years. It's usually the best option if you need a given amount of money all at once for a home improvement, say, or a business start up. A credit line replaces that certainty with flexibility. You might arrange for a $50,000 line, for example, and then borrow $1,000, $15,000 or whatever simply by writing a check. Payback is flexible, too, often with interest only payments allowed during, say, a ten year borrowing period. (After that, you must stop borrowing and repay the balance over the next 15 years or so or refinance.) A line of credit is the clear cut winner for people who will be borrowing irregular amounts of money to pay college tuition, perhaps, or buy a new car. The interest rates charged on fixed loans and lines of credit are generally similar. Currently, there's a slight edge about one fourth of a percentage point in favor of loans. THE URGE TO MERGE DEBTS When newlyweds Rachael and Bret Shefter took out a line of credit last summer, they capitalized on two trends in the home equity market: lenders' more liberal guidelines on how much may be borrowed against a home's equity and the shift toward using the borrowed money for debt consolidation rather than home improvement. The Shefters had bought their three bedroom house in California's San Fernando Valley last spring with a 20% down payment. Until the past few years, mortgage lenders would have turned away homeowners trying to borrow against only 20% equity. But competition and the low default record of home equity loans has encouraged lenders to approve loans that bring the owner's overall debt up to 90% and even 100% of a home's value. Countrywide Funding (800 669 6659), a national lender based in Pasadena, Cal., okayed a credit line for the Shefters that raised their debt to 90% of their home's value. But they're paying for being so highly leveraged, with a 12.25% rate that, at 3.5 percentage points over prime, is two points higher than Countrywide's 80% loan to value deals. The Shefters weren't offered a discounted introductory rate or a closing cost waiver. "It's not the world's greatest interest rate, but it's better than some we found," says Bret, a lawyer. And 'it certainly beats the 17% to nearly 22% they were paying on the credit card debt they were able to retire. Deals that allow up to 100% of equity borrowing are even more costly. Expect to pay up to five points over prime, or 13.75% currently. And 100% deals may come with dollar caps a top loan amount of $10,000, for example regardless of how much equity you have in your home. Judith Shine, a financial planner in Englewood, Colo., says she "just cringes" when sbe sees advertisements for 100% equity loans. Borrowers considering 90% and 100% equity deals should take pause, she says. "I think that it's a perfect sign not that you are overextended, but that you're getting ready to be." Shine isn't enthusiastic about using lower rate home equity credit to get rid of high rate credit card balances, either. With home equity lines, she says, people tend to stretch out the debt repayment longer maybe ten or 15 years. "And I can tell you that people go out and run those cards up again," Shine warns. Despite her aversions, Shine and most of her clients have set up lines of credit for the flexibility they offer.

Last Updated ( Thursday, 22 January 2009 )