Using a Home Equity Loan as a Debt Consolidation Loan

Using a line of credit based on your home equity, has become a popular way for consumers to handle unexpected family expenses, or to pay off accumulated debts. But a home equity loan is not always the simplest option for you. Keep the following in mind:

• If you decide a home equity loan or line of credit is not for you, the law allows three days after opening an equity account to cancel it, but the cancellation must be made in writing.
   
• Home equity loans are made more attractive by low introductory interest rates that have a limited period. You need to ask what the rate will be when that offer expires.
   
• Opening a home equity loan account has associated costs, including the application fee, title search, lawyer's fees, and an appraisal.
   
• A line of credit usually has a variable interest rate. When the rate goes up, so will your payments.
   
• You may be liable for transaction fees, each time you borrow money.

It is essential that you read the home equity contract carefully, and ask questions to ensure that every point is clear, before you sign it and agree to the terms. Loans may come with very low introductory rates that provide a big surprise when that introductory period is over. They can also have large upfront opening fees, closing fees, balloon payments, or ongoing costs such as annual fees.

The best approach, is shop around and compare home equity lines of credit. Take a list of questions like the ones below. Use a checklist provided by the FTC. You can get one by contacting them at Public Reference, Federal Trade Commission, Washington, D.C. 20580; (202) 326-2222. TDD call (202) 326-2502.)

Is a home equity line of credit, right for me?
You must remember that while a home equity line gives you a substantial sum of money at a very low interest rate, that rate will rise at the end of the introductory period, and continue to flex with a variable interest rate. However, there are tax advantages not associated with other types of loans. You can discuss this with your tax advisor when you are comparing home equity lines.

The "down" side of this type of credit, is that you are using your home as collateral, and placing it at risk if you are fall into arrears. Balloon payments at the end of the term, may lead to further borrowing to pay off the initial debt, or you may find yourself unable to get refinancing. Should you decide to sell your home, you'll be required to pay off the line of credit at that time.

A viable alternative may be a second mortgage installment loan. This does place a second mortgage on your home, but has the advantages of receiving the entire amount borrowed in one lump sum instead of separate withdrawals or check against a line of credit account. The interest rates on these loans are usually fixed, as are the payment amounts.

You also have the option of credit lines drawn against your credit cards, or unsecured lines of credit that don't use your residence as collateral. There are also specific loans for things such as cars or tuition, which may have better interest rates and payment plans.

How much can I borrow against my home?
Your outstanding debts as well as your credit record will be taken into account when a lender considers your application for a home equity line of credit. You may be able to borrow up to 85% of the home's value, minus whatever you still owe on your mortgage.

Make sure that you find out how long the home equity loan is for. Check also, to see if there is a minimum withdrawal amount on opening, and whether there are minimum/maximum withdrawals after that. You'll also need to know whether the line is accessed by credit card, check, or both.

It is essential that you are aware of the "draw" period, if there is one on the home equity plan you are considering. This is a time frame set by the lending institution, in which you can access the line of credit. When the period expires you *may* be able to renew the LOC, and maybe not. You may find yourself in need of the balance of the line of credit you were allowed, but unable to access it. When the draw expires, some plans require full payment of any outstanding amount, while others will allow repayment over a fixed period.

What kind of interest rates go with a home equity loan?
Loan rates vary between institutions, which is why it is important to shop around. Start by comparing the APR, annual percentage rate, which is the cost of credit on an annual basis. But don't forget, that the APR is not your only cost associated with a home equity loan. There are opening fees, closing fees, and points, all of which are important, especially if you are trying to decide between the line of credit, and a second mortgage where the APR includes the total credit cost for the year.

Most home equity lines of credit carry variable interest rates, which means the rate and your payments may rise and fall though out the year. You may start off low, especially with an introductory offer, but fluctuating markets can drive your payments up in no time. A fixed rate, if available, may cost more in the first few months, but over the life of the loan, gives you stability of interest rates and monthly payment amounts.

If a variable rate is attached to your offer, check out all the terms. What is the periodic cap- the limit on the number of interest rate changes at one time? What is the lifetime cap- the limit of interest rate changes over the life of the loan? Indexes, like the prime rate, are used by institutions to determine how much to raise or lower their rates. Ask which index is used, how often it can change and by how much? Check the margin as well- the amount added to the interest, making the total of the rate you are charged. Even if you start out on a variable rate loan, it is worth asking if at some point you can convert to a fixed rate.

What are the costs of opening a home equity line of credit?
You will end up paying many of the same costs associated with the original purchase/mortgage of your house- lawyer's fees, title search, assessment, etc. as well as "points" (a percentage of the amount you are borrowing). Costs like these can really add to your overall debt, especially if you don't use the full loan amount. It is sometimes possible to negotiate a waiver of some fees with the lender.

Are there ongoing costs associated with a home equity loan?
The total cost of your loan may rise with annual membership or participation fees which must be paid whether you utilize the line of credit or not. You may also have to pay a transaction fee whenever you withdraw money.

What will the payments be during the home equity loan period?
A variable interest rate can affect your payments in two ways. One, because it rises and falls with the market, and two, because you are likely paying off the debt and the balance owing gets smaller. Make sure you know whether your payments are just covering the interest, or are going on the principal as well. Even if you are paying on the principal, if it is not a high enough amount, there may be money owing at the end of the loan period. It is also advisable to know when you will be considered in arrears, and under what circumstances the lender would consider you in default and demand payment in full.

What about payments at the end of the home equity loan period?
If you are facing a "balloon" payment, or outstanding balance at the end of the loan period, you may want to renegotiate you payment plan, or ask your lending institution to agree ahead of time, and in writing, to finance this leftover debt if you cannot pay it off in one sum.

Are there any safeguards in a home equity loan?
The Federal Truth In Lending Act, requires that a lender disclose to you all costs associated with your loan at the time of application. They must give you the APR, the payment terms, and any associated charges such as title searches and attorney's fees. They must also explain the variable rate feature, and supply you with general information in printed form, on home equity plans.

The TIL Act also serves as protection against any changes in the terms of the account, between application and opening. If you decide not to proceed with the loan, all fees paid by you, must be returned.

Risking your home is a major move. Should you decide to cancel a home equity loan, you have three days after the opening to do it. Notice must be delivered to the lender in writing, then all fees paid must be returned to you.

After your home equity plan is opened, and you are making the agreed on payments, the lender in most cases may not: terminate your plan, change the terms of payment or accelerate payback of the outstanding amount. If your contract permits, credit advances on your account may be halted by the lender, if the interest rates exceed the maximum cap as noted in your agreement.