Interest is the most expensive cost in a loan.
Rates on home equity loans are either fixed or
variable. Fixed rates stay the same over the life
of the loan while variable rates move up and down.
Competition among lenders has many of them offering
low introductory "teaser" rates, one
or two points below prime, that are good for about
six months. After that, the rate is adjusted according
to a public index that reflects interest trends.
The lender uses that index to decide how much
the annual percentage rate will change during
the life of the loan. Banks must use a public
index rather than an internal one that could be
arbitrary.
Most banks use The Wall Street Journal prime
rate or the prevailing rates on Treasury notes
as the basis for their home equity loan interest
rate calculations. The all-important Journal number
is derived from the base rate on corporate loans
posted by at least 75 percent of the 30 largest
U.S. banks.
The lender adds a margin, or fixed number of
percentage points, to the index to determine the
new rate each time it is adjusted. This can happen
once a year or more. Each point is equal to 1
percent of the loan, so if you're borrowing $10,000
one point would be $100.
By law, variable-rate loans must have a cap on
how high the interest can climb over the life
of the loan. Most variable-rate lines of credit
also have a cap that limits how much, and how
often, the interest rate can change during the
course of a year. This cap typically prevents
the rate from jumping more than two percentage
points in a year.
Some plans also limit how low your interest can
fall if rates drop.
The best news is that the interest on home equity
loans is usually tax-deductible for up to $100,000
on your home's principal mortgage balance.
Of course, the sooner you pay off the loan, the
less it will cost you in interest.
Tips
1. Shop around for a lender that offers "prime
for life." In any case, you shouldn't pay
more than two points above prime.
2. Check rates at your credit union or community
bank.
3. Ask the lender:
• How much can a variable interest rate
go up at one time?
• What is the cap on a variable rate?
• What is the maximum monthly payment? The
minimum?
• How often can you change the rate?
• What index do you use and how high has
it risen in the past?
• Is the loan amortized, or is there a balloon
payment? If not fully amortized, how much is the
balloon and when is it due? (If there is a balloon,
you don't want to be surprised when the end of
the loan rolls around and there is a lump sum
payment due you hadn't been aware of.)
4. Chart out how high your payments would be at
different rates by going to bankrate.com's (tm)
mortgage calculator or ask your banker to do it
for you. Your lender is required to tell you how
a variable rate is figured.
5. Understand that you cannot compare the annual
percentage rate -- the cost of the loan each year,
expressed as a percentage -- of a term second
mortgage with a line of credit. They are calculated
differently. The APR for a term equity loan takes
into account the interest rate plus points and
other finance charges. For a line of credit, the
APR is based on the periodic interest rate and
does not include points and other costs.
6. Electronic payments sometimes get you a fractional
break on interest rates. You usually need to have
your loan from the same bank you have a checking
or savings account to do this.
7. Before you sign, consult a tax adviser about
deductions on your loan because there are exceptions
to deductibility.
|
