Many homeowners leverage their homeâ€™s equity to take out a loan, but thereâ€™s a danger in doing that. Hereâ€™s what to look out for and what to expect when you do it.
Make Sure You Can Pay Back The Loan
Write out a budget. Thatâ€™s the simplest way to determine whether you can afford to repay your loan or not. A budget sounds so easy – if you spend less than you earn, you have savings. This savings can be used to pay a new home equity loan payment.
But, as simple as it is to write down everything you spend your money on, most people donâ€™t make budgets. They â€œwing it.â€ Donâ€™t be like most people. Take the time to write down everything. Then, spend a week or two thinking about whether you can really afford to take on another payment, and whether you really want to.
Shop Around For The Best Rates
Shopping for a home equity loan isnâ€™t difficult – not with lenders advertising rates online. Whatâ€™s tricky is determining whether you qualify for the advertised rate. You usually have to have excellent credit to get the advertised rate.
So, before you walk into a lenderâ€™s office, or call someone up on the phone, pull your credit report from annualcreditreport.com and see whether you have any derogatory remarks on your report. If you do, you have three options:
- You can wait for the derogatory remarks to fall off.
- You can dispute any erroneous remarks that shouldnâ€™t be on there.
- You can ask your lender about rapid rescoring when you fill out the loan paperwork.
The third option is one that most people donâ€™t really understand. Rapid rescoring is a process whereby the lender will try to boost your score to get you a lower interest rate. This is usually a supplemental service that costs extra, but it can be worth it to have someone do this for you.
Basically, the lender tries to get erroneous or old derogatory remarks dropped from your credit report for you. Itâ€™s fast (taking a few days to complete) and you donâ€™t have to bother with the credit bureaus yourself (which can take 30 days or more).
Donâ€™t Rush Into A Mortgage
Never rush into anything – especially when it comes to home equity loans. If youâ€™re considering a standard HELOC or home equity loan, ask questions about the repayment terms, the interest rate, the total volume of interest youâ€™ll be paying, and whether thereâ€™s a penalty for early payoff.
If youâ€™re older and considering a reverse mortgage (a special kind of home equity loan for seniors which turns your homeâ€™s equity into a pseudo savings account), consider these reverse mortgage questions before you apply.
Consider Fixed Vs Variable Loans
Most people automatically assume that a fixed mortgage is the way to go. But, historically, variable rate mortgages have offered lower interest rates over the long-term. So, donâ€™t immediately dismiss them.
What you have to determine is whether you think interest rates will stay low, or reasonably low, or whether you think that rates will rise substantially. If you think rates will rise substantially, it might make sense to get a fixed mortgage. If you think rates will fall or stay flat, or only rise slightly, the variable rate option is probably a better deal.
At the end of the day, either decision is not going to make or break you. Remember, you can always refinance the loan later if things donâ€™t work out (provided that your credit is still in good shape).
Always Have a Debt Acceleration Plan
No one really likes being indebted to someone else. It can be dangerous if you lose your job, and itâ€™s expensive even if youâ€™re able to make all of your scheduled loan payments. Make sure you have a definite payoff schedule, and that you have a debt-acceleration plan in place to speed up the payoff.
Debt acceleration means that you are able to pay extra on the loan principal or youâ€™re able to save up money on the side and use tax deferral and compound interest to accelerate the payoff date.
The important thing is that you have a plan to pay off your debts, or at least make 6 months of mortgage payments, if you lose your job or canâ€™t make them for some other reason.
Donâ€™t walk into a home equity loan without this kind of fallback plan. Mortgage lenders are not forgiving if you miss even one payment so it pays to have a plan before you make your first payment.
Matt Evans has worked in mortgage lending for nearly 20 years. In 2008, when the real estate market crashed, Matt decided to focus exclusively on helping seniors with reverse mortgages. He meets with each and every client face-to-face to answer questions and make sure they are comfortable with the major decision. He also enjoys sharing his industry insights online.