Home Equity

Home Equity Line of Credit-How to Avoid Five Traps and Give a Look To An Opportunity

If you need money and you are a home owner, a home equity line of credit (also known as "HELOC") could help you solve your problem. With this, you can borrow money against the equity in your home, i.e. the difference between your home value and your current mortgage debt.

As you are taking money against your home, asking for a home equity line of credit is a serious task; you must sure you are going to get a type of service which is fitting exactly with your needs.

Here are a list of five points that you have to care about if you want avoiding some nasty effects:

1) Cost of the application process

Some lenders offer home equity line of credits with a large one time fee. Others don't mention it but continue to add "underground" costs. Ask your lender clear informations of this and an explanations of the items in the legal documents about costs.

2) Low starting interest rate

Sometimes you could benefit of a low starting interest rate. This is for certain an attractive option, however you are warned to check how the rates are going to become just after the initial period. Usually they become much higher.

How you can check it? Simply check the contract details, find exactly what is the financial base rate yours will be based to, ask where you can check it (usually the base rates are published on newspapers), and ask for projections of the base rate value for your home equity line of credit expected lending period. It's advisable also you ask for a second opinion to one of your preferred bank competitors.

3) Variable interest rates

Home equity lines of credit with variable interest rates computes the actual interests to be paid on a base rate defined in the contract you are signing. Usually this will be the interest rate set by the Federal Reserve Board.

As the interest rate varies, you can't predict exactly what you are going to give back in your next payment. This isn't necessarily a bad thing; however it could explode if you are not careful. Why? Give a look at the next two points.

4) Beware of balloon payments

Sometimes home equity line of credit lead to a so called "balloon payment", i.e. a big payment to be give back by the borrower after an initial credit period is expired. This could put you in serious trouble

5) Beware of too high payments

Sometimes there is no balloon payment danger, but you have to pay each and every month a substantial payment. This could constraint you too much if your financial status requires more flexibility. Again, check how things are with your lender, and read carefully your contract. Clear what is the minimum payment you have to give back each month, so you can evaluate if it's sustainable by you.

Consider the alternatives to the home equity line of credit

This has always to be done, especially if the previous points and, most important, fuzzy answers from the lenders make things for you much harder. For example you could ask for a credit line that doesn't have your home as collateral; you could resort to your business or other properties you have; or you could opt for an income based loan.

If your only chance is to exploit your home equity but can't stand for the traps of home equity line of credit, then you could go for a home equity loan. It's less flexible but could be a lot safer for you.