As with
primary home mortgages, you will have to
make a decision between a
home equity loan
with a fixed interest rate versus one with
an adjustable interest rate.
Fixed rate
interests remain the same for the life of
the loan, while adjustable rate interest can
rise or fall, depending on the index to
which they are tied to.
Fixed
interest rates have the advantage of
allowing you to know exactly how much you
will be paying in interest over the life of
your loan, and how much your monthly
payments will be. But you often pay for this
peace of mind with a higher interest rate
than if you went with an adjustable interest
rate.
The
interest rate on an adjustable
home equity
loan can change between adjustment periods
depending on the index it is tied to. Most
lenders use the prime rate on The Wall
Street Journal or the prevailing rates on
U.S. Treasury Bills as their index when
calculating interest rates. In addition to
the index, lenders also charge a margin,
which is the profit the lender will make on
the loan, and is a fixed number of
percentage points. Together, the index and
the margin will determine your interest
rate. Adjustments typically occur every six
to twelve months, but can occur as often as
every month.
Adjustable rate
home equity loans also have
a life cap which limits how high the
interest rate can climb over the life of the
loan, and some even limit how low it can
drop. Additionally, most generally limit how
much, and how often, the interest rate can
change over the course of a year.
As with
home mortgages,
home equity loans are tax
deductible, usually for up to $100,000 on
the home's principal
mortgage balance.
Some general tips when
shopping for a home equity loan
-
Check rates at your
credit union or bank.
-
Ask the lender
- How high
your interest rate can go up at one
time?
- What is
the cap on a variable rate?
- What is
the maximum/minimum monthly payment?
- How
often can you change the rate?
- What
index do they use? Ask for a recent
history of interest rate changes.
- Is the
loan amortized, or is there a balloon
payment?
- If not fully
amortized, how much is the balloon and
when is it due?
-
Be sure you have enough
to make monthly payments if the interest
rate reaches the maximum limit.
-
Understand that the APR
for a second
mortgage and a line of
credit are calculated differently. APR
for a second mortgage takes points and
other finance charges into account,
while the APR on a line of credit is
based on a periodic rate and does not
include points or other costs.
-
If you make an electronic
payment, you may be able to get a
fractional reduction in interest rate.
-
Consult a tax adviser to
make sure your loan is tax deductible.
