|
More and more lenders are offering home equity lines of credit. By using the equity (1) in your home, you may qualify for a sizable amount of credit, available for use when and how you please, at an interest rate (2) that is relatively low.
Furthermore, under the tax law – depending on your specific situation – you may be allowed to deduct the interest because the debt is secured by your home.
If you are in the market for credit, a home equity plan may be right for you. Or perhaps another form of credit would be better. Before making a decision, you should weigh carefully the costs of a home equity line against the benefits. Shop for the credit terms that best meet your borrowing needs without posing undue financial risk. And remember, failure to repay the amounts you’ve borrowed, plus interest, could mean the loss of your home.
A home equity line of credit is a form of revolving credit in which your home serves as collateral. Because the home is likely to be a consumer’s largest asset, many homeowners use their credit lines only for major items such as education, home improvements, or medical bills and not for day-to-day expenses.
With a home equity line, you will be approved for a specific amount of credit – your credit limit(3), the maximum amount you may borrow at any one time under the plan. Many lenders set the credit limit on a home equity line by taking a percentage (say, 75%) of the home’s appraised value and subtracting from that the balance owed on the existing mortgage. For example:
| Appraised Value of Home |
$100,000 |
| Percentage |
x 75% |
| Percentage of appraised value |
=$75,000 |
| Less balance owed on mortgage |
-$40.00 |
| Potential credit |
$35,000 |
In determining your actual credit limit, the lender will also consider your ability to repay, by looking at your income, debts, and other financial obligations as well as your credit history.
Many home equity plans set a fixed period during which you can borrow money, such as 10 years. At the end of this “draw period”, you may be allowed to renew the credit line. If your plan does not allow renewals, you will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period (“the repayment period”), for example, 10 years.
Once approved for a home equity line of credit, you will most likely be able to borrow up to your credit limit whenever you want. Typically, you will use special checks to draw on your line. Under some plans, borrowers can use a credit card or other means to draw on the line.
There may be limitations on how you use the line. Some plans may require you to borrow a minimum amount each time you draw on the line (for example, $300) and to keep a minimum amount outstanding. Some plans may also require that you take an initial advance when the line is set up.
If you decide to apply for a home equity line of credit, look for the plan that best meets your particular needs. Read the credit agreement carefully, and examine the terms and conditions of various plans, including the annual percentage rate (APR)(4) on the costs of establishing the plan. The APR for a home equity line is based on the interest rate alone and will not reflect the closing costs (5) and other fees and charges, so you’ll need to compare these costs, as well as the APRs, among lenders.
Home equity lines of credit typically involve variable(6) rather than fixed interest rates. The variable rate must be based on a publicly available index(7) (such as the prime rate published in some major daily newspapers or a U.S. Treasury bill rate); the interest rate for borrowing under the home equity line changes, mirroring fluctuations in the value of the index. Most lenders cite the interest rate you will pay as the value of the index at a particular time plus a “margin”(8), such as 2 percentage points. Because the cost of borrowing is tied directly to the value of the index, it is important to find out which index is used, how often the value of the index changes, and how high it has risen in the past as well as the amount of the margin.
Lenders sometimes offer a temporarily discounted interest rate for home equity lines – a rate that is unusually low and may last for only an introductory period, such as 6 months.
Variable-rate plans secured by a dwelling must, by law, have a ceiling or cap(9) on how much your interest rate may increase over the life of the plan. Some variable-rate plans limit how much your payment may increase and how low your interest rate may fall if interest rates drop.
Some lenders allow you to convert from a variable interest rate to a fixed rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.
Plans generally permit the lender to freeze or reduce your credit line under certain circumstances. For example, some variable-rate plans may not allow you to draw additional funds during a period in which the interest rate reaches the cap.
May of the costs of setting up a home equity line of credit are similar to those you pay when you buy a home. For example:
- A fee for a property appraisal to estimate the value of your home
- An application fee(10), which may not be refunded if you are turned down for credit
- Up-front charges, such as one or more points(11) (one point equals 1 percent of the credit limit)
- Closing costs, including fees for attorneys, title search, and mortgage preparation and filing; property and title insurance; and taxes.
In addition, you may be subject to certain fees during the plan period, such as annual member or maintenance fees(12) and a transaction(13) fee every time you draw on the credit line.
You could find yourself paying hundreds of dollars to establish this plan. If you were to draw only a small amount against your credit line, those initial charges would substantially increase the cost of the funds borrowed. On the other hand, because the lender’s risk is lower than for other forms of credit, as your home serves as collateral, annual percentage rates for home equity lines are generally lower than rates for other types of credit. The interest you save could offset the costs of establishing and maintaining the line. Moreover, some lenders waive some or all of the closing costs.
Before entering into a plan, consider how you will pay back the money you borrow. Some plans set minimum payments(14) that cover a portion of the principal (the amount you borrow) plus accrued interest. But (unlike with the typical installment loan) the portion that goes towards principal may not be enough to repay the principal by the end of the term. Other plans may allow payment of interest alone during the life of the plan, which means that you pay nothing toward the principal. If you borrow $10,000, you will owe that amount when the plan ends.
Regardless of the minimum required payment, you may choose to pay more, and many lenders offer a choice of payment options. Many consumers choose to pay down the principal regularly as they do with other loans. For example, if you use your line to buy a boat, you may want to pay it off as you would a typical boat loan.
Whatever your payment arrangements during the life of the plan – whether you pay some, a little, or none of the principal amount of the loan – when the plan ends you may have to pay the entire balance owed, all at once. You must be prepared to make this “balloon payment”(15) by refinancing it with the lender, by obtaining a loan from another lender, or by some other means. If you are unable to make the balloon payment, you could lose your home.
If your plan has a variable interest rate, your monthly payments may change. Assume, for example, that you borrow $10,000 under a plan that calls for interest-only payments. At a 10 percent interest rate, your monthly payments would be $83. If the rate rises over time to 15 percent, your monthly payments will increase to $125. Similarly, if you are making payments that cover interest plus some portion of the principal, your monthly payments may increase, unless your agreement calls for keeping payments the same throughout the plan period.
If you sell your home, you will probably be required to pay off your home equity line in full immediately. If you are likely to sell your home in the near future, consider whether it makes sense to pay the up-front costs of setting up a line of credit. Also keep in mind that renting your home may be prohibited under the terms of your agreement.
If you are thinking about a home equity line of credit, you might also want to consider a traditional second mortgage loan. A second mortgage provides you with a fixed amount of money repayable over a fixed period. In most cases the payment schedule calls for equal payments that will pay off the entire loan within the loan period. You might consider a second mortgage instead of a home equity line if, for example, you need a set amount for a specific purpose, such as an addition to your home.
In deciding which type of loan best suits your needs, consider the costs under the two alternatives. Look at both the APR and other charges. Do not, however, simply compare the APRs, because the APRs on the two types of loans are figured differently:
The APR for a traditional second mortgage loan takes into account the interest rate charged plus points and other finance charges.
The APR for a home equity line of credit is based on the periodic interest rate alone. It does not include points or other charges.
The federal Truth in Lending Act requires lenders to disclose the important terms and costs of their home equity plans, including the APR, miscellaneous charges, the payment terms, and information about any variable-rate feature. And in general, neither the lender nor anyone else may charge a fee until after you have received this information. You usually get these disclosures when you receive an application form, and you will get additional disclosures before the plan is opened. If any term (other than a variable-rate feature) changes before the plan is opened, the lender must return all fees if you decide not to enter into the plan because of the change.
When you open a home equity line, the transaction puts your home at risk. If the home involved is your principal dwelling, the Truth in Lending Act gives you 3 days from the day the account was opened to cancel the credit line. This right allows you to change your mind for any reason. You simply inform the lender in writing within the 3-day period. The lender must then cancel its security interest(16) in your home and return all fees – including any application and appraisal fees – paid to open the account.
- The difference between the fair market value (appraised value) of the home and the outstanding mortgage balance
- The periodic charge, expressed as a percentage, for use of credit
- The maximum amount that may be borrowed under the home equity plan
- The cost of credit on a yearly basis expressed as a percentage
- Fees paid at closing, including attorneys fees, fees for preparing and filing a mortgage, fees for title search, taxes, and insurance
- An interest rate that changes periodically in relation to an index. Payments may increase or decrease accordingly
- Published rate that serves as a base for the interest rate changed on a home equity line and also as the base for rate changes used by the lender
- The number of percentage points the lender adds to the index rate to determine the annual percentage rate
- A limit on how much the variable interest rate may increase during the life of the plan
- Fees that are paid upon application. May include charges for property appraisal and a credit report
- One point is equal to 1 percent of the amount of the credit line. Points must usually be paid at closing and are in addition to monthly interest
- An annual charge for having the line of credit available. Charged regardless of whether or not the line is used
- A fee charged each time you draw on your credit line
- The minimum amount that you must pay (usually monthly) on your account. Under some plans, the minimum payment may cover interest only; under others, it may include both principal and interest
- A lump-sum payment that may be required when the plan ends
- An interest that a lender takes in the borrower’s property to ensure repayment of a debt
This information is adapted from the brochure “What You Should Know about Home Equity Lines of Credit” provided by the Federal Reserve. For more information go to www.federalreserve.gov
This disclosure contains important terms and provisions of our Home Equity Line of Credit Plan. You should read it carefully and keep a copy for your records.
Conditions for Disclosed Terms: All of the following terms described below are subject to change. If the disclosed terms change (other than a change due to fluctuations in the index in a variable rate plan), prior to opening the plan, and you decide, as a result, not to enter into this agreement with us, you are entitled to a refund of all fees paid in connection with your application.
Security Interest and Risk to Home: The bank will be taking a security interest in your home. You could lose your home if you do not meet the obligations in your agreement with us.
Possible Actions by Creditor: Under certain circumstances, we may (1) terminate your line and require payment of the outstanding balance in full; (2) refuse to make additional extensions of credit or reduce the credit limit; and/or (3) make specific changes in your agreement with us. Upon request, you may receive information about the conditions under which such actions may occur.
Payment Terms: You can obtain advances of credit on your line for three (3) years (the “draw” period). This agreement shall be automatically renewable from year to year unless we give you notice to the contrary at least 30 days prior to the date specified in your agreement. Your payment will be due monthly and will be the greater of $100 or 1.5% of the unpaid principal balance including any accrued finance charges. If the minimum payment is made, these payments may not repay all of the outstanding balance, which will result in a balloon payment being due at maturity.
- Minimum Payment Example: If you took a single $10,000 advance, obtained no additional extensions of credit, and the ANNUAL PERCENTAGE RATE was 10.25%, it would take three years to pay off the line with the following conditions: The payments would range from a high of $150.00 to $119.57 with a final balloon payment of $7,919.52.
Fees and Charges: There may be fees imposed by the bank such as a loan origination fees of $150, a tax service fee of $52 and a flood life of loan fee of $4. There may also be fees to third parties ranging from $0-$500, and may include an appraisal of your home if required. We may require you to provide title insurance, the cost of which depends on the dollar amount of your line. Upon request, we will give you an itemization of the fees you will have to pay the third parties. Finance charges begin to accrue on the date loans are posted to the account.
Minimum Withdrawal Requirement: The minimum credit advance you can receive is $200.
Tax Implications: You should consult a tax advisor regarding the deductibility of interest and charges under the plan.
Variable Rate Features: This line has a variable rate feature which means that the annual percentage rate (corresponding to the periodic rate) and minimum payment can change as a result. The annual percentage rate includes only interest and no other costs. The annual percentage rate is based on the value of an index. The index which is used is the highest prime rate published in the Wall Street Journal “Money Rates” table. The annual percentage rate applied to your line is determined by adding a margin to the value of the index. Ask us for the current index value, margin, discount or premium and annual percentage rate. After you open a credit line, rate information will be given to you on periodic statements that we send you.
Rate Changes: The annual percentage rate can change monthly and will change on the last day of the month. The maximum annual percentage rate that can apply during the term of your line of credit shall not exceed 18%. Apart from this rate “cap”, there is no limit on the amount by which the rate may change during any one-year period.
- Maximum Rate and Payment Example: If the annual percentage rate reached the maximum of 18%, and you had a balance of $10,000, the minimum monthly payment would be $150.00. This annual percentage rate could be reached in the first month of the draw period.
Negative Amortization: Under some circumstances, your payments will not cover the finance charges that accrue, and negative amortization will occur. Negative amortization will increase the amount that you owe us and reduce your equity in your home.
Historical Example: The following table illustrates how the annual percentage rate and minimum monthly payments for a single $10,000 credit advance would have changed based on fluctuations in the index over the past 15 years. The index values are from the beginning of September of each year and reflect a margin that has been used within the last six months. Your margin may differ from that listed below.
The table assumes that no additional credit advances were taken that year, that only the minimum payments were made and that the rate remained constant during each year. It does not necessarily indicate how the index of your payments will change in the future. The table lists the year, the index for that year, the margin added to the index, the appropriate annual percentage rate, and a minimum monthly payment made for that year.
| Year |
Index (%) |
Margin (%) |
Annual Percentage Rate (%) |
Minimum Monthly Payment |
| 1993 |
6.00% |
2.00% |
8.00% |
$150.00 |
| 1994 |
7.75% |
2.00% |
9.75% |
$128.88 |
| 1995 |
8.75% |
2.00% |
10.75% |
$121.33 |
| 1996 |
8.25% |
2.00% |
10.25% |
|
| 1997 |
8.50% |
2.00% |
10.50% |
|
| 1998 |
8.50% |
2.00% |
10.50% |
|
| 1999 |
8.25% |
2.00% |
10.25% |
|
| 2000 |
9.50% |
2.00% |
11.50% |
|
| 2001 |
6.50% |
2.00% |
8.50% |
|
| 2002 |
4.75% |
2.00% |
6.75% |
|
| 2003 |
4.00% |
2.00% |
6.00% |
|
| 2004 |
4.50% |
2.00% |
6.50% |
|
| 2005 |
6.50% |
2.00% |
8.50% |
|
| 2006 |
8.25% |
2.00% |
10.25% |
|
| 2007 |
8.25% |
2.00% |
10.25% |
|
I have received a completed copy of this disclosure statement and the Federal Reserve Board Publication "When Your Home Is On The Line." |