Top 10 Mistakes when Getting a home-equity loan
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- Not knowing if your loan has a pre-payment penalty clause. If
you are getting a "NO FEE" home-equity loan, chances are there's a hefty
pre-payment penalty included. You'll want to avoid such a loan if you are
planning to sell or refinance in the next three to five years.
- 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 a large equity line indicates
a large potential payment, which can make it difficult to qualify for
- Not understanding the difference between an equity loan and an equity
line. An equity loans is closed--i.e., you get all your
money up front and make fixed payments until it is paid if full. An equity line is
open--i.e., 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 lines, you can only be charged interest on the outstanding
Use an equity loan when you need all the money up front--e.g., for home improvements,
debt consolidation, etc. Use an equity line of credit when you have a periodic need
for money, or need the money for a future event--e.g., childrens' college
tuition in the future.
- Not checking the lifecap on your equity line of credit. Many credit
lines have lifecaps of 18 percent. Be prepared to make payments at the
highest potential rate.
- Getting a home-equity loan from your local bank without shopping around. Many
consumers get their equity line of credit from the bank with which they have their
checking account. By all means, consider your bank, but shop around before
making a commitment.
- Not getting a good-faith estimate of closing costs. See item
number four above.
- 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--check with
an accountant or CPA.
- 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 yourhome-equity line with the rate on your credit
card or auto loan.
Effective rate = rate * (1 - tax bracket)
Example: The rate of the home equity line of credit is 12 percent,your tax bracket
is 30 percent, your effectiverateis: .12 * (1 - .3) = .12 * .7 = .084 = 8.4
If your credit card is higher than 8.4 percent, the equity loan is cheaper.
- Getting a home equity line of credit when you plan 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 second) when refinancing
the first mortgage. If you plan on refinancing your first, check with your
mortgage company to find out if getting a second will cause your refinance
to be turned down.
- Getting a home equity line of credit to pay off your credit cards when your
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, tear it up!