Suppose you need to get your hands on a fast $20,000 to pay bills or finance a child’s college education. But you’re also over your head with 18 percent credit card debt. There’s still a balance on your mortgage, but you’ve built up $70,000 of equity in the home.
The answer could be a home equity line of credit, or a straight home equity loan. The average interest rate will be only 9 percent–half of what credit cards charge. Banks typically will lend up to 70 to 80 percent of your equity, which in your case would be as much as $56,000. But more lenders these days will go to 100 percent because of competition.
The big downside, of course, is that if you use home equity to pay off your credit cards, you’re swapping unsecured debt for secured debt. If you take off for Brazil and never pay the credit card issuer, they’re stuck. With a home equity loan, they can grab the house.
Remember two things about that attractive 9 percent rate: The rate usually is variable, not fixed. Lenders quote that only as an “introductory” rate, which in a few months will adjust upward to the prime rate (now 8.25 percent) plus anywhere from 1 to 3 percentage points. That’ll push the low-ball 9 percent to as high as 11.25 percent.
But there’s a new type of home equity line of credit out there, one which is more complicated yet offers more options in the way you borrow and repay.
Lenders are allowing customers to move part or all of what they owe on their credit line into a regular loan with a fixed rate. In some cases, the balance can be moved back into the line. The practice is popular in the western part of the country and beginning to move east, according to Bank Rate Monitor.
The accounts, called convertible home equity lines of credit, give borrowers essentially two borrowing modes for the price of one application, including just one appraisal. They give lenders another way to attract customers, something that became tougher when people refinanced their mortgages and paid off their old lines of credit in the process.
These convertible equity lines are complicated, and hard to compare. Here’s how a typical one might work: The borrower signs up for the credit line at a variable rate set at prime plus 1 percentage point. Based on the new prime, that would be 9.25 percent.
The borrower has 20 years during which to draw against the credit line. In that time, the minimum monthly payment is 1 percent of the balance owed or $50, whichever is greater. After the 20 years, the customer can no longer take out any money, and must pay off what is owed within the next 15 years.
The withdrawal and repayment periods, along with the small monthly payment, are fairly common among home equity lines of credit. What you also might bump into is a “convertible option.”
The bank allows customers to move a minimum of $5,000 into a loan whose fixed rate is prime plus 2 percentage points. As of now, the rate would be 10.25 percent.
The term is based on the amount of the loan–as long as 10 years on loans of less than $20,000 and as long as 20 years on $20,000 or more.
A customer can have up to three loans at the same time, but can sign up for no more than two in any given 12-month period. Another difference: The bank might charge $50 for each loan after the first one.
On each loan, the monthly payment is based on an amortization schedule, just like a mortgage.
Choosing a convertible equity line can be very difficult, but there are several criteria you can apply:
– Which lines of credit and loans have the lowest rate? If the bank keeps its adjusted rate close to prime, that’s good. For example, Chase Manhattan, New York, which is merging with Chemical Bank, offers the prime rate for the life of the loan provided you transfer at least $50,000 from your home equity account at another bank.
– How high can the rates go? Most banks cap their equity line rate at 18 percent, others are as high as 24 percent.
– What are the required payments? Some are too small, and so you keep a high balance and high interest expenses.
– What are the annual fees? You’ll probably see between $65 and $75, but if you don’t use any of your credit line in a year, you also could be hit with an “inactivity” fee.
