Top 10 Mistakes When Getting a Home Equity Loan
1. Not Knowing Whether Your Loan Has a Pre-Payment Penalty Clause. If you are getting a "NO
FEE" home-equity loan, chances are there is some kind of pre-payment penalty included. Make
sure you know the terms. That's not necessarily a deterrent as long as the rate is competitive.
After all, the lender is paying all closing costs. Just be certain the terms are reasonable for the
costs they are paying, and are not onerous.
2. Getting Too Large a Credit Line. When you get too large a credit line, you can be turned down
for other loans because some lenders calculate your payments based upon the available credit,
not the used credit. Even when your equity line has a zero balance, having an equity line that is too
large indicates a large potential payment, which can make it difficult to qualify for other loans.
3. Not Understanding the Difference Between an Equity Loan and an Equity Line. An Equity Loan
is a closed-end loan, that is, you get all your money up front and make fixed payments until it is
paid in full. An Equity Line is open-ended loan- you can get numerous advances for various
amounts as you desire. Most Equity Lines are accessed through a checkbook or a credit card. For
both Equity Loans and Equity Lines, you can only be charged interest on the outstanding principal
balance.
4. Not Checking the Lifecap on Your Equity Line. Many credit lines have lifecaps of 18 percent or
more. Be prepared to make payments at the highest potential rate, or consider taking an Equity
Loan with a fixed rate.
5. Getting a Home Equity Loan from Your Local Bank Without Shopping Around. Many
consumers get their Equity Line from the bank where they have their checking account. By all
means, consider your bank, but shop around, just like you would with any other major decision,
before making a commitment. Your local mortgage broker has access to lenders all across the
country, and may have better terms available for you.
6. Not Receiving a Good Faith Estimate. Within three business days after your mortgage broker
receives your loan application, you must receive a written statement of fees associated with the
transaction. This is both the law and the best way to determine what you'll pay for your loan. Bring
the Good Faith Estimate (GFE) with you when you sign final loan documents at settlement. And
while you should not be expected to pay fees which are substantially different from those contained
in your GFE, remember that your mortgage broker is estimating many of the fees that are actually
charged by other service providers necessary to your transaction. In short, your mortgage broker
will try to estimate everyone's fees as closely as possible, but it's impossible for every estimate to
be exact.
7. Assuming That Your Home Equity Loan is Fully Tax-Deductible. In some instances, your Home
Equity Loan is NOT tax deductible. Do not depend on your mortgage company for information
regarding this matter. There are limitations on how much mortgage interest can be deductible, so
check with your accountant, CPA, or tax advisor.
8. Assuming That a Home Equity Loan is Always Cheaper Than a Car Loan or a Credit Card.
Even after deducting interest for income tax purposes, a credit card can be cheaper than a credit
line. To find out, compare the effective rate of your Home Equity Line with the rate on your credit
card or auto loan.
Effective rate = rate * (1 - tax bracket)
Example: If the rate of the Home Equity Line is 12 percent, and your tax bracket is 30 percent, then
your effective rate is: .12 * (1 - .3) = .12 * .7 = .084 = 8.4 percent.
If your credit card is higher than 8.4 percent, the Equity Loan is cheaper. If not, use the credit card.
(Just be sure to monitor it becuase credit card rates can rise too.)
9. Getting a Home Equity Line of Credit When You Plan to Refinance Your 1st Mortgage in the
Near Future. Mortgage companies look at the combined loan amounts when refinancing (i.e., the
1st mortgage balance plus the 2nd mortgage balance). If you plan on refinancing your first, check
with your mortgage company to find out if getting a 2nd mortgage will cause your refinance to be
turned down. (Remember that Equity Loans and Equity Lines are 2nd mortgages.)
10. Getting a Home Equity Line to Pay-Off Your Credit Cards When Spending is Out of Control
When you pay off your credit cards with an Equity Line, don't continue to abuse your credit cards. If
you can't manage the plastic, cut 'em up! It may be hard at first, but over time you will see an
improvement, and be glad you did.
back to FAQ
1. Not Knowing Whether Your Loan Has a Pre-Payment Penalty Clause. If you are getting a "NO
FEE" home-equity loan, chances are there is some kind of pre-payment penalty included. Make
sure you know the terms. That's not necessarily a deterrent as long as the rate is competitive.
After all, the lender is paying all closing costs. Just be certain the terms are reasonable for the
costs they are paying, and are not onerous.
2. Getting Too Large a Credit Line. When you get too large a credit line, you can be turned down
for other loans because some lenders calculate your payments based upon the available credit,
not the used credit. Even when your equity line has a zero balance, having an equity line that is too
large indicates a large potential payment, which can make it difficult to qualify for other loans.
3. Not Understanding the Difference Between an Equity Loan and an Equity Line. An Equity Loan
is a closed-end loan, that is, you get all your money up front and make fixed payments until it is
paid in full. An Equity Line is open-ended loan- you can get numerous advances for various
amounts as you desire. Most Equity Lines are accessed through a checkbook or a credit card. For
both Equity Loans and Equity Lines, you can only be charged interest on the outstanding principal
balance.
4. Not Checking the Lifecap on Your Equity Line. Many credit lines have lifecaps of 18 percent or
more. Be prepared to make payments at the highest potential rate, or consider taking an Equity
Loan with a fixed rate.
5. Getting a Home Equity Loan from Your Local Bank Without Shopping Around. Many
consumers get their Equity Line from the bank where they have their checking account. By all
means, consider your bank, but shop around, just like you would with any other major decision,
before making a commitment. Your local mortgage broker has access to lenders all across the
country, and may have better terms available for you.
6. Not Receiving a Good Faith Estimate. Within three business days after your mortgage broker
receives your loan application, you must receive a written statement of fees associated with the
transaction. This is both the law and the best way to determine what you'll pay for your loan. Bring
the Good Faith Estimate (GFE) with you when you sign final loan documents at settlement. And
while you should not be expected to pay fees which are substantially different from those contained
in your GFE, remember that your mortgage broker is estimating many of the fees that are actually
charged by other service providers necessary to your transaction. In short, your mortgage broker
will try to estimate everyone's fees as closely as possible, but it's impossible for every estimate to
be exact.
7. Assuming That Your Home Equity Loan is Fully Tax-Deductible. In some instances, your Home
Equity Loan is NOT tax deductible. Do not depend on your mortgage company for information
regarding this matter. There are limitations on how much mortgage interest can be deductible, so
check with your accountant, CPA, or tax advisor.
8. Assuming That a Home Equity Loan is Always Cheaper Than a Car Loan or a Credit Card.
Even after deducting interest for income tax purposes, a credit card can be cheaper than a credit
line. To find out, compare the effective rate of your Home Equity Line with the rate on your credit
card or auto loan.
Effective rate = rate * (1 - tax bracket)
Example: If the rate of the Home Equity Line is 12 percent, and your tax bracket is 30 percent, then
your effective rate is: .12 * (1 - .3) = .12 * .7 = .084 = 8.4 percent.
If your credit card is higher than 8.4 percent, the Equity Loan is cheaper. If not, use the credit card.
(Just be sure to monitor it becuase credit card rates can rise too.)
9. Getting a Home Equity Line of Credit When You Plan to Refinance Your 1st Mortgage in the
Near Future. Mortgage companies look at the combined loan amounts when refinancing (i.e., the
1st mortgage balance plus the 2nd mortgage balance). If you plan on refinancing your first, check
with your mortgage company to find out if getting a 2nd mortgage will cause your refinance to be
turned down. (Remember that Equity Loans and Equity Lines are 2nd mortgages.)
10. Getting a Home Equity Line to Pay-Off Your Credit Cards When Spending is Out of Control
When you pay off your credit cards with an Equity Line, don't continue to abuse your credit cards. If
you can't manage the plastic, cut 'em up! It may be hard at first, but over time you will see an
improvement, and be glad you did.
back to FAQ
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