Home equity loans allow borrowers to use the equity in their home -- the home's appraised value minus the mortgage amount -- as collateral on loans using their equity.
Typical costs:
The interest rate on a home equity loan ranges from 5%-8.59%, or $500-$859 annually per $10,000 borrowed, depending on geographic location and the borrower's credit. For example, according to BankRate.com[1] , interest rates range from 5%-8.49% in Nevada, while they range from 6.99%-7.29% in New York.
The interest rate on a home equity line of credit ranges from 3.25%-6.99%, or $325-$699 annually per $10,000 borrowed, depending on the region and the borrower's creditworthiness.
Borrowers typically pay closing costs on home equity loans. These can amount to as much as 3% of the loan amount, or $300 per $10,000 borrowed.
Traditionally known as a second mortgage, a home equity loan is a one-time, lump-sum loan that is amortized, which means it is paid off over a defined amount of time (between five and 10 years, depending mainly on the size of the loan) with a fixed payment. Home equity loans typically have a fixed interest rate.
A home equity line of credit, or HELOC, is an open-ended line of credit with the home serving as collateral, making the loan less risky for the banks. This means banks can offer lower interest rates for HELOCs, but because these interest rates are variable they can go up or down.
Financial advisors suggest home equity loans for large, one-time bills, while HELOCs are useful for longer-term debts, such as education expenses or home renovations.
Home equity loans or lines of credit are not available on investment properties.
Additional costs:
Because the loans are based on equity, borrowers typically pay for a property appraisal to determine the home's value. Appraisals average $300-$500.
Borrowers who choose a home equity line of credit are often charged an annual fee of about $50, and may be charged transaction fees each time they borrow money from the credit line.
Many banks charge an early payoff penalty that typically amounts to 2%-3% of the loan. BankRate.com offers tips on how to avoid this penalty[2] .
Discounts:
As with a mortgage, the amount paid in interest to home equity loans is tax deductible[3] .
Some banks offer interest-rate discounts when the borrower maintains another account with that institution or when automatic payment is set up. For example, Bank of America offers a 0.25% discount for each scenario. On a HELOC, Bank of America offers another 0.25% discount for loans of $25,000 or more.
Shopping for a home equity loan:
The Federal Trade Commission offers a list of common pitfalls[4] of home equity loans and how to avoid them. The commission offers another list of considerations for a home equity line of credit[5] , including advice on what to do if the bank reduces the credit line.
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