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Not checking to see if your loan
has a pre-payment penalty clause. If you are getting a "NO
FEE" home-equity loan, chances are that it has a hefty
pre-payment penalty clause. This can be very important if you
are planning to sell your house or refinance in the next 3-5
years.
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Getting too large a credit line.
When you get too large a credit line, you can get turned down
for other loans, because some lenders calculate your payments
based on the available credit and not just the used credit.
Having a large equity line indicates a large potential payment,
which makes it difficult to qualify for loans. Note : this argument
holds even if your equity line has a zero balance.
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Not understanding the difference
between an equity loan and an equity line. An equity loan is
closed i.e. you get all your money up front and then make fixed
payments on that loan, until you pay it off. An equity line
is open i.e. you can get an initial advance against the line
and then reuse the line as often as you want during the period
that the line is open. Most equity lines are accessed through
a checkbook or a credit card. On equity lines, you only pay
interest on the outstanding balance.
Use an equity loan when you
need all the money up front e.g. home improvement, debt consolidation.
Use an equity line if you have an ongoing need for money
or need the money for a future event e.g. you need to pay for
your child's college tuition in 3 years.
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Not checking the lifecap on your
equity line. Many credit lines have lifecaps of 18%. Be prepared
to pay payments at higher interest levels if rates move upwards.
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Getting a home-equity loan from
your local bank without shopping around. Many consumers get
their equity line from the bank that they have a checking account
with. Use your bank, but shop around first.
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Not getting a good-faith estimate
of closing costs. Your mortgage company is required to provide
you with a written good-faith estimate of closing costs within
3 working days of receiving the application.
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Assuming that your home-equity
loan is tax deductible. In some instances, your home-equity
loan is NOT tax deductible. Perhaps you make too much and fall
into the AMT trap, or perhaps you have pulled out more than
$100,000 cash from your home. Do not depend on your mortgage
company for information regarding this matter check with an
accountant or CPA.
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Assuming that a home-equity
loan is always cheaper than a car loan or a credit card. A credit
card at 6.9% is cheaper than a credit line at 12% even after
the tax deduction. To compare rates, compute the effective rate
of your home-equity loan, with the rate on a credit card or
auto loan. Effective rate = rate * (1 - tax bracket) Example
: If the rate of the home-equity loan is 12% and your tax bracket
is 30%, your effective rate is : 12% * (1-0.3) = 12%*0.7 = 8.4%
If your credit card is higher than 8.4%, then the equity loan
is cheaper, otherwise it is not.
Besides the interest rate, you
may also want to compare monthly payments and other terms of
the loan.
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Getting a home-equity line of
credit if you plan to refinance your first mortgage in the near
future. Many mortgage companies look at the combined loan amounts
(i.e. the first loan plus the second) even when they are refinancing
the first mortgage. If you plan on refinancing your first, check
with your mortgage company to find out if getting a second will
cause your refinance to get turned down.
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Getting a home-equity line
to pay off your credit cards if your spending is out of control!
When you pay off your credit cards with your equity line, don't
go out and charge up those credit cards again and put your house
on the line! If you can't manage the plastic, tear it up!
