Shopping Around Advised for Home-Equity Loans
If you’ve considered all the pros and cons of a home-equity credit line and decided that the account would make good financial sense, be prepared to do a lot of comparison shopping.
Most home-equity loans being offered have adjustable interest rates. As a result, financial planners say, it’s extremely important to find out how often the rate will change and what index will be used to make those periodic adjustments.
Generally, it’s best to use a lender that links its changes to an index that’s easy to locate. Two widely used indexes utilized in calculating interest-rate adjustments are the prime rate and the one-year rate on Treasury bills.
Most California lenders are currently charging an interest rate that’s linked to the prime rate. However, cautions San Francisco financial planner Lawrence Krause, some lenders use the prime rate published in financial sections of newspapers, while others use their own prime rate that is sometimes higher than the published rate.
“When a loan officer starts talking about the prime rate, find out which one he’s talking about,” Krause says.
The interest rate on the home-equity credit line will reflect the lender’s index rate plus a “spread” that allows the lender to cover its cost of servicing the account and provides it with a slight profit margin.
The rate on Great Western’s “Easy Access” account, for example, is currently 9.5%--two percentage points above the published prime rate of 7.5%.
Home Federal Savings & Loan Assn., however, is currently only charging about 9.25% on its new home-equity accounts because its spread is only 1.75 percentage points above its 7.5% prime rate.
Check Initial Costs
Just because Home Fed’s interest rate is lower doesn’t necessarily mean its home-equity account is a better deal than Great Western’s.
If you go into Home Fed tomorrow to set up a $50,000 home-equity line of credit, you’ll have to pay two “points"--$1,000--just to open up the account. In addition, you’ll have to pay from $100 to $300 for a title search on your home, and a $35 annual fee to keep the account open.
On the other hand, Great Western will only charge you 1 1/2 points--$750--to set up that same $50,000 credit line. The costs of your title search will be about the same.
You’ll have to pay a $40 annual fee for a credit line at Great Western, $5 more than Home Fed’s annual charge. However, notes a Great Western spokesman, that $40 fee gets you both a checkin1730175331Great Western will also waive the $40 fee the first year the account is opened.
Some other lenders are charging lower interest rates than either Home Fed or Great Western. While some of them may be better deals, others are making up for their low rates by charging higher loan-origination fees, $50 to $150 home-appraisal fees, and so-called “garbage fees” for documentation charges, credit reports and the like.
Generally, says Don Stearns, tax partner in the Los Angeles real estate consulting and accounting firm of Kenneth Leventhal & Co., “the more points you pay, the more flexible the lender will be” on other terms of the loan.
Some lenders also charge you as much as 2% or 3% of your existing credit line each year just to keep the line open, says financial planner Krause.
“Or, they might insist that you keep, say, $10,000 in cash in the bank,” he adds. “If you fall behind on your payments, they want to be able to take the cash out of your account instead of foreclosing on your house.”
Wait Until Money Needed
Since the up-front fees entailed in setting up a home-equity account can be hefty, most financial planners say you shouldn’t open one up until you need the money.
“Don’t open an account unless you really need the cash, and you really need it right now,” says John Cahill, another San Francisco financial planner. “It’s expensive money to have just sitting there.”
Another benefit of waiting to open a home-equity account, Cahill adds, is that rates and terms may grow more attractive as more lenders enter the business.
It might pay off to include out-of-state lenders in your search for a home-equity account. Some of the most attractive deals are being offered by lenders based in the Southeast, according to Philip Kavesh, an accountant and personal financial counselor in the Los Angeles office of Laventhol & Horwath.
Lump Sum Payment
Repayment schedules are another important consideration. Some lenders offer “interest-only” accounts which allow you to pay only your monthly interest charges. This means that your monthly payments will be relatively low, but that you’ll have to pay back the entire loan amount in one lump sum several years down the road.
Others insist that you pay your interest charges and a small portion of your principal each month. As a result, your monthly payment will be higher, but you won’t have to come up with a big lump sum several years from now.
As with any adjustable-rate mortgage, you should insist that changes in the rate of your home-equity loan have a “cap” of no more than five percentage points, experts say. In other words, a loan with an initial interest rate of 9.5% should never be able to rise above 14.5%, even if interest rates rise sharply.
“You should really look for a loan with a cap--or a loan that has a fixed rate--unless you’re a gambler and think rates are going to go lower,” says tax expert Stearns.
Some loans also have prepayment penalties, which experts say will be costly if you want to pay the loan off early or plan to move relatively soon.
These are only some of the factors you’ll need to consider in picking the home-equity credit line that’s right for you. Your best-bet might be to visit a financial planner or accountant before you even start your search to see if such an account is your best financing option. If it is, a financial expert can help you pick the loan that best suits your individual needs.