Home Equity Loan: FAQ

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Question: Should I think about taking out a home equity loan to pay off my credit card debt?

Answer: In principle, paying off credit cards with a home equity loan sounds like a good idea. It lowers your interest rate. You pay less each month. You are paying with tax-deductible dollars. This lowers your taxes (if you itemize – see your tax consultant). But there are some serious problems to think about. If you continue using your credit card to ring up more debt, you are out of control. Before you know it, you will have more credit card debt again to pay off. And you will now have a home equity loan to pay off. This means you have an increasing debt burden to pay. And you have put your own home at risk of foreclosure.

Question: I have $100,000 equity in my home. Can I take out a home equity loan for $100,000?

Answer: Most banks willingly allow 80 percent loan to value ratio. That means that you could automatically qualify for a home equity loan of $80,000, assuming your credit is OK. However, if you want a load greater than 80 percent of your equity, a bank must charge a higher interest rate premium for the added risk it takes when your loan exceeds the nominal 80 percent loan to value ratio. If you are willing to pay a higher interest rate, then your good credit can secure loans as high as 100 percent of your home equity -- or even higher -- with values of 110 percent to 120 percent quoted by some lenders.

Question: So what happens if I do exceed the 80 percent loan to value ratio?

Answer: Your lender may require you to pay what is called PMI, “Private Mortgage Insurance”. Unless you are in need of the extra loan amount, and can avoid this extra cost by using the standard 80 percent equity ratio.

Question: Do lenders charge fees when I take out a home equity loan?

Answer: Lenders vary widely on what fees they charge. Some lenders charge no fees at all, as long as your loan meets a minimum size, and you keep the loan a minimum amount of time. Such a no-cost home-equity loan usually has an early pre-payment penalty. Other lenders may offer you a loan that is of any size (even zero – a line of credit), but may charge their own costs to originate the loan and to make an appraisal.

Question: What happens if I fall behind on my home equity loan and can not pay it back?

Answer: If you are in default, then after a pre-set period of time as stipulated in your lending agreement, the lender can foreclose on your home. This means that you can lose all the equity you have in your home. Your home can be sold by the lender to repay the loan.

Question: What is a home equity line of credit?

Answer: A home equity line of credit allows you to write checks secured by the value of your home. If you exceed the upper limit on your line of credit, your checks may bounce, or the lender may charge you a penalty and a higher interest rate. Exactly what the lender can do when you exceed your maximum line of credit depends on the terms written into your home equity line of credit lending agreement.

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