Understand the terms of home equity loans

[Jan 23, 2011.]

 

A big part of why the housing sector of the economy crashed a few years ago had to do with people taking out loans they didn't understand. Don't ever let that happen to you. Consumer protections are in place, such as, the terms of home equity loans being required to be given to you in advance. Knowing those terms, and understanding them, will always be the responsibility of the home owner.

What are the terms of home equity loans?

The terms of home equity loans will be disclosed, up front, within a few days of making the home loan application. Terms include the interest rate and any possible adjustments, the number of years before the balance is due to be paid in full, and how the payments will be structured.

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Interest rate - Home equity loans can have either a fixed interest rate, or an adjustable interest rate. The terms of the agreement will tell you, clearly, which type of home loan you will receive. If the interest rate is fixed, then the rate disclosed will not change during the life of the loan. If the interest rate is adjustable, the agreement will specifiy when and how the interest rate will adjust.

Possible adjustments to the interest rate - An adjustable rate mortgage will have an index and a margin. The index will be a moving number. Common indices are Prime Rate, the London Inter-Bank Offered Rate (LIBOR), and the Constant Muturity Treasury (CMT). The margin is a fixed percentage over the index that represents the profit the bank expects to make for loaning the funds. If the index is Prime Rate, currently 3.25 percent, and the margin is 2.0 percent, the fully index rate would be 5.25 percent. The fully indexed rate is what is used to calculate the monthly payment due.

Term of repayment - The word term is also used specifically for the number of years before the balance is due to be repaid in full. You may have a 40 year term, or a 5 year term, or something in between. Look carefully at the dates in the agreement. Make sure you know exactly how long you have to repay the money you want to borrow.

Payment structure - Knowing how much you are required to pay each month, to avoid default, is really the heart of the matter. Payments can be structured in a variety of ways: negative amortization, interest only, or fully amoritized. A negative amortization payment actually adds to the principal each month, rather than paying down the balance owed. Most home equity loans offer interest only payment, which only covers interest and leaves the principal unchanged. A fully amortized loan means that if you make your monthly payments as scheduled, the balance will be paid in full by the end of the loan's term.

 

About Author:

Renee Morgan has been a loan officer for over eighteen years. She is also a freelance writer and guest expert for radio and TV.