But at some point the loan will need to be repaid and having a strategy on repayment beforehand can make the entire home financing process go that much smoother. For those with poor or bad credit, is it even more important to figure out a repayment plan, since their past poor credit repayment habits may arise again.
So before you enter in a home equity loan or home equity line of credit agreement, sit down and formulate a plan on how you will repay the loan. Make sure you fully understand the terms set down by the lender, and if there are any terms you do not understand, make sure they are explained clearly and that you understand them fully before you sign the papers.
Some home equity loans or home equity lines of credit determine a minimum monthly payment based on your credit history, which includes a pre-determined percentage of the principal or amount you borrowed, plus any interest that has accrued. However, it is important to note that because your payment goes toward the principal and the interest, you may not have paid enough to cover the principal by the end of the loan term (unlike a typical installment loan). There are also still some other types of home equity loan and home equity line of credit plans that may only allow you to pay the interest during the life of the payment plan, meaning you will have paid nothing toward the actual interest during that time. For instance, if you borrow $25,000, that is the amount you will owe when the length of the payment plan ends.
But thankfully, many lenders offer a choice of payment plans that allow you to choose to pay some, none or a portion of the principal during the life of the plan. But no matter what payment schedule you choose, at the end of the plan you will have to pay the entire amount owed, principal and interest. This is called a balloon payment and if you are unable to pay it off in full when the payment plan ends, there is the possibility you could lose your home.
Depending on your situation, you can pay the balloon payment in full, refinance it with the lending institution or pay it by obtaining a loan from a different lending institution.
In some cases, you may have a home equity loan or home equity line of credit with a variable interest rate (more common with a home equity line of credit), which means your monthly payments may go up or down depending on the Prime Rate. For instance, you may begin with an interest rate of only 10 percent but over time it may rise to 15 or 20 percent, which will increase your monthly payment (principal and interest). While most variable rate mortgages have a periodic cap or lifetime cap that limits how high the percentage rate can go, you should still be prepared to pay the higher end of the percentage rate if necessary. Also, make sure you check the margin on your loan as well. The margin is the amount that is added to the prime rate by the lender that determines the amount of interest you are charged. Finally, note that for a home equity loan, while the percentage rate may change, the terms are usually locked in at 10 or 20 years.
The other option is a fixed rate home equity loan or home equity line of credit in which the percentage rate is locked in for the life of the loan. Fixed rates are not connected to any federal index but usually simply a competitive advertised rate. It is to your advantage to check with various lenders for the lowest rate. And while comparing their annual percentage rates (APR) is a good rule or thumb, a truer comparison of their rates would be to check their other fees such as closing costs and points. This will give you a better idea of what you will end up paying.
When it comes to a fixed rate home equity loan or home equity line of credit, the advantage, as you might imagine, is that you can be assured of what your monthly payment will be regardless of the current economic conditions and that there is the possibility that you could end up paying far less in interest than the current Prime Rate. On the other hand, should the Prime Rate go down, you could end up paying more in interest than you could with a variable rate mortgage. But for those seeking a home equity loan or home equity line of credit, knowing exactly what your monthly payments will be might to your financial advantage. Also, some lenders may allow you to change a variable rate loan into a fixed rate loan so you may wish to inquire about this.
Lastly, know that if you sell your home, you will most likely be required to pay of your home equity loan or home equity line of credit in full right away. And while renting your home might seem to be a good option to not only generate funds to pay your existing home equity loan or line of credit while purchasing another home, some home equity loan and home equity line of credit contract terms do not permit you to rent your home during the term period.