This checklist does not tell you the procedure to get home equity loan, It is designed to help you to protect yourself when you’re getting a home equity credit line. The purpose behind writing this article is to educate people out there about common pitfalls of home equity credit lines, so that they can protect themselves, when they take this important decision of their life.
1. Check your credit line for a pre-payment penalty clause.
If you are getting a “NO FEE” credit line, chances are it has a pre-payment penalty clause. This can be very important plus expensive, especially if you are planning to refinance or sell your home in the next two to five years.
2. Never apply for too large a credit line.
If you get too large a credit line, you can be turned down for other loans. Some lenders calculate your credit line payments based on the available credit, even when your credit line has a zero balance. Having a large credit line indicates a large potential payment, which makes it difficult to qualify for loans.
3. Understand the difference between an equity loan and a credit line.
An equity loan is closed–i.e., you get all your money up front, then make payments on that fixed loan amount until the loan is paid. An equity credit line is open–i.e., you can get an initial advance against the line, then reuse the line as often as you want during the period the line is open. Most credit lines are accessed through a checkbook or a credit card. Credit line payments are based upon the outstanding balance.
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Use an equity loan when you need all the money up front–e.g. home improvements or debt consolidation.
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Use a credit line if you have an ongoing need for money or need the money for a future event–e.g., you need to pay for your child’s college tuition in three years.
4. Check life cap on your equity line.
Many credit lines have life caps of 18%. Be prepared to make high interest payments if rates move upwards.
5. Shop around.
Many consumers get their credit line from the bank with which they have their checking account. Shop around before deciding to use your bank.
6. Get a good-faith estimate of closing costs.
Within three working days after receipt of your completed loan application, your mortgage company is required to provide you with a written good-faith estimate of closing costs.
7. Double Check that the interest on your home credit line/loan is tax deductible.
In some instances, the interest on your home credit line is NOT tax deductible. It is beyond the scope of this document to provide tax advice or quote from the IRS code. Contact an accountant or CPA to determine your particular situation.
8. Home equity line is not always cheaper than a car loan or a credit card.
A credit card at 6.9% can be cheaper than a credit line at 12%, even after the tax deduction. To compare rates, compare the effective rate of your credit line with the rate on a credit card or auto loan.
Effective rate = rate * (1 – tax bracket)
Example: If the rate of the home equity credit line is 12% and your tax bracket is 30%, your effective rate is12% * (1 – 0.3) = 12% * 0.7 = 8.4%
If your credit card is higher than 8.4%, the credit line is cheaper. Besides the interest rate, you may also want to compare monthly payments and other terms of the loan.
9. Make sure you are not planning to refinance your first mortgage in the near future.
Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the equity line/loan) even though they are refinancing only the first mortgage. If you plan on refinancing your first loan, check with your mortgage company to determine if getting a second line/loan will cause your refinance to be turned down.
10. Don’t Let your spending out of control!
When you pay off your credit cards with your credit line, don’t put your home on the line by charging large amounts on your credit cards again! If you’re taking this risk and cannot manage the plastic, get rid of it!
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