Home Equity Can Be a Rich Resource to Tap - But Do it Wisely
Your brother-in-law has one. So does your boss. Your neighbor used his to launch a career as an Elvis impersonator.
We're talking about home equity lines of credit, which allow homeowners to borrow against their homes at favorable interest rates. In 2004, home equity borrowing rose 35% to $431 billion, according to SMR Research, a market-research firm.
The furious pace of home borrowing has continued in 2005, lenders say. Contributing to the trend:
Home prices continue to rise. When your home's value increases, so does your equity. The median price for existing homes rose 11.4% in March from a year earlier, the National Association of Realtors reported last week.
Rates remain low. The average rate for a home equity line of credit was 6.06% last week, Bankrate.com says. In most cases, home equity lines are also tax-deductible. By contrast, the average rate for a variable-rate credit card was 13.4%.
But there's a drawback to these popular loans. They typically carry a variable rate that fluctuates with market rates. Rates on home equity lines have been rising since last summer. If the Federal Reserve Board raises rates again, they'll go up even more.
Home equity loans offer more certainty. With these loans, you typically receive a lump sum and agree to pay a set amount every month until the loan is repaid. Unlike a home equity line, the interest rate is usually fixed. But security comes at a price: The average rate for a home equity loan is 7.05%, according to Bankrate.com.
New products
Higher rates could deter some homeowners from borrowing, but lenders are working overtime to prevent that from happening.
Wells Fargo, for example, has introduced a hybrid home equity loan that offers a fixed rate for three, five or seven years, then converts to a variable rate. Borrowers have the option of making interest-only payments during the fixed-rate period, says Doreen Woo Ho, president of Wells Fargo's consumer credit group.
U.S. Bank tested a different approach last fall. Customers who took out a home equity line of credit received a discount of one-quarter of 1% every six months, up to 1% below the prime rate.
The promotion, which lasted two months, generated record sales, says Trent Spurgeon, vice president of consumer products. U.S. Bank is analyzing the results and hasn't decided whether it will renew the promotion, Spurgeon says.
Choosing a loan
If you fail to pay your credit cards, you'll get nasty phone calls from collection agencies. Default on a home equity line or loan, and you could lose your house. So before you borrow, consider:
How you plan to use the money. In general, home equity lines of credit are useful for ongoing cash needs, such as medical bills or college tuition. Many homeowners set up equity lines for emergencies.
A home equity loan is usually a better choice if you need a loan for a specific purpose, such as a new kitchen, and plan to pay it off over several years.
A home equity loan may also be a better choice for homeowners with lots of credit card debt that will take a while to repay, says Michael McCarthy, general manager for mortgage lender Ditech.com. "The home equity loan, with a fixed rate and amortized schedule, is a better solution for a consumer who is consolidating debt over a longer period of time," he says.
Upfront and back-end costs. Many lenders have eliminated or reduced closing costs for home equity lines and loans. Ditech, for example, charges a $49 flat fee for its home equity loans and lines of credit.
But increasingly, lenders are charging prepayment penalties. The penalties typically apply to loans paid off within the first three to five years, and range from six to 12 months' interest, says Anthony Hsieh, president of LendingTree.com, an online service that matches borrowers with lenders.
Some penalties are "soft," which means they're waived if you sell your home, Hsieh says. A "hard" penalty is triggered if you pay off the loan early for any reason, including selling your home, he says.
How long you plan to stay in your home. If you expect to move in a few years, you'll be able to use the proceeds to pay off your loan. But if you plan to stick around, you'll have to continue making monthly payments until the loan is repaid, Hsieh says.
Before making any decisions, talk to several lenders and find out what they're offering.
"Any time interest rates rise," Hsieh says, "people start getting more creative."
