Home Equity Loan Costs

Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home.  For example:  (1)  A fee for a property appraisal, which estimates the value of your home; (2) An application fee, which may not be refundable if you are turned down for credit; and / or (3) Up-front charges, such as one or more points (one point equals one percent of the credit limit); (4) Other closing costs, which include fees for attorneys, title search, mortgage preparation and filing, property and title insurance, as well as taxes; (5) Certain fees during the plan, i.e., some plans impose yearly membership or maintenance fees; (6) You also may be charged a transaction fee every time you draw on the credit line.

You could find yourself paying hundreds of dollars to establish the home equity line of credit.  If you were to draw only a small amount against your credit line, the charges and closing costs outlined above would substantially increase the cost of the funds borrowed.  On the other hand, the lender's risk is lower than for other forms of credit because your home serves as collateral.  Thus, annual percentage rates for home equity lines of credit are generally lower than rates for other types of credit.  The interest you save could offset the initial costs of obtaining the line.  In addition, some lenders may waive a portion or all of the closing costs.

How will you repay your home equity loan?  Before entering into a plan, consider how you will pay back any money you might borrow.  Some plans set minimum payments that cover a portion of the principal (the amount you borrow) plus accrued interest. But, unlike the typical installment loan, the portion that goes toward principal may not be enough to repay the debt by the end of the term. Other plans may allow payments of interest alone during the life of the plan, which means that you pay nothing toward the principal.  If you borrow $10,000, you will owe that entire sum when the plan ends.

Regardless of the minimum payment required, you can pay more than the minimum and many lenders may give you a choice of payment options. Consumers often will choose to pay down the principal regularly as they do with other loans.  For example, if you use your home equity loan to buy a boat, you may want to pay it off as you would a typical boat loan.
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Whatever your payment arrangements during the life of the home equity loan --whether you pay some, a little, or none of the principal amount of the loan--when the plan ends you may have to pay the entire balance owed, all at once. You must be prepared to make this balloon payment by refinancing it with the lender, by obtaining a loan from another lender, or by some other means.  If you are unable to make the balloon payment, you could lose your home.

With a variable rate, your monthly payments may change. Assume, for example, that you borrow $10,000 under a plan that calls for interest-only payments.  At a 10 percent interest rate, your initial payments would be $83 monthly.  If the rate should rise over time to 15 percent, your payments will increase to $125 per month.
Even with payments that cover interest plus some portion of the principal, there could be a similar increase in your monthly payment, unless the agreement calls for keeping payments level throughout the plan.

When you sell your home, you probably will be required to pay off your home equity line in full.  If you are likely to sell your house in the near future, consider whether it makes sense to pay the up-front costs of setting up an equity credit line.  Also keep in mind that leasing your home may be prohibited under the terms of your home equity agreement.

Next topic:  What type of home equity loan is best for you?
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