As home prices began their long slide, banks pulled the plug on home-equity lending. But as the housing market emerges from the doldrums, home-equity borrowing is beginning to perk up, too. A home-equity loan, which usually comes with a fixed monthly payment and interest rate, is best for projects or purchases with a one-time, fixed cost, such as consolidating debt. Home-equity lines of credit, or HELOCs, make sense for ongoing expenses, such as long-term home-improvement projects or college-tuition payments. HELOCs usually have a variable rate that’s tied to the prime rate, plus or minus some percentage. On a fixed-rate loan, a borrower with good credit (with a FICO score of about 720 to 740) may pay 6.5 percent; that same borrower would likely pay the prime rate (currently 3.25 percent) plus 1.5 to 2 percentage points on a HELOC.
As with first mortgages, underwriting standards for loans backed by home equity are strict. Total borrowing – including both your mortgage and home-equity loan or line of credit – typically can’t exceed 80 percent of the home’s current market value. Compare terms from several lenders, including banks with which you already have accounts or loans. Those lenders may be willing to give you a break on rates or fees. And check with regional banks and credit unions, too. They avoided much of the fallout from the housing bubble and have been leading the way in granting new home-equity loans and HELOCs to borrowers with good credit.
Before you apply, get a free credit report at annualcreditreport.com to make sure your record is free of errors, and purchase your credit score (go to myfico.com and click on “Check my FICO score” to buy it for $20). You’ll likely need a minimum FICO score of about 680 to 700 to qualify.
Closing costs, which can include an appraisal and credit check as well as notary and documentation fees, could run $500. With a HELOC, you may be able to avoid those fees if there’s a clause limiting early termination; as long as you keep the line open for a certain period (typically three years), the lender absorbs the fees. Check whether a HELOC has a lifetime cap on the rate. Caps are typically about 9 percent to 10 percent, says Fred Arnold, director and treasurer for the National Association of Mortgage Brokers.
Small banks and credit unions may be more inclined than large banks to take personal circumstances into account, especially if your qualifications are borderline in one area because of a temporary setback.
Lisa Gerstner is a staff writer at Kiplinger’s Personal Finance magazine. Send your questions and comments to moneypower@kiplinger.com. And for more on this and similar money topics, visit www.Kiplinger.com.
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