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Need a loan? Think twice about using your home as collateral

February 02, 2001

Need a loan? Think twice about using your home as collateral



If you need money to pay bills or make home improvements and think refinancing, a second mortgage or a home equity loan is the answer, consider your options carefully. If you can't make the required payments, you could lose your home, as well as the equity you've built. Don't let anyone talk you into using your home to borrow money you don't need.

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Not all loans or lenders are created equally. Some unscrupulous lenders target elderly and low-income homeowners and those with credit problems. These lenders may offer loans based on the equity in your home, not on your ability to repay the loan. High interest rates and credit costs can make borrowing money against your home expensive.

Consult with your attorney, financial adviser or someone else you trust before making loan decisions. Nonprofit credit and housing counseling services can also be useful in helping manage credit and make decisions about loans.

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Shop around - costs can vary. Contact several lenders, including banks, savings and loans, credit unions and mortgage companies. Ask each lender about the best loan for which you qualify.

Compare the annual percentage rate (APR). The APR is the most important thing to compare when shopping for a loan. It takes into account not only the interest rate, but also points - one point equals 1 percent of the loan amount - mortgage broker fees and other credit charges the lender requires the borrower to pay, expressed as a yearly rate. Generally, the lower the APR, the lower the cost of your loan. Ask if the APR is fixed or adjustable - that is, will the APR change?

Points and fees


Ask about points and other fees you'll be charged. These charges may not be refundable if you refinance or pay off the loan early. Points are usually paid in cash at closing, but may be financed. If you finance the points, you'll pay additional interest and increase the total cost of your loan.

The term of the loan


How many years will you make payments on the loan? If you're getting a home-equity loan that consolidates credit-card debt and other shorter-term loans, the new loan may obligate you for a longer period.

The monthly payment


What's the amount? Will it stay the same or change? Is there a balloon payment? This is a large payment usually at the end of the loan term, often after a series of low monthly payments. When the balloon payment is due, you must come up with the money. If you can't, you may need another loan - which means new closing costs, and points and fees.

Is there a prepayment penalty? These are extra fees that may be due if you pay off the loan early by refinancing or selling your home. Prepayment penalties may force you to keep a high-rate loan. Getting out of the loan may be too expensive. Try to negotiate this penalty out of your loan agreement.

Will the interest rate for the loan increase if you default?

An increased interest rate provision says if you miss a payment or pay late, you may have to pay a higher interest rate for the rest of the loan term. Try to negotiate this provision out of your loan agreement.

Does the loan include a charge for any type of voluntary credit insurance, such as credit life, disability or unemployment insurance?

Will insurance premiums be financed as part of the loan? If so, you'll pay additional interest and points and increase the total cost of the loan. How much lower would the monthly payment on your loan be without credit insurance? Will the insurance cover the length of your loan and the full loan amount? Before deciding to buy voluntary credit insurance from a lender, think about whether you need the insurance, and check with other insurance providers about their rates.

Ask each lender to provide, as soon as possible, a written "good-faith estimate" that lists all charges and fees you must pay at closing. Although not always required, these estimates make it easier to compare terms from different lenders.

At closing, before you sign anything, ask for an explanation of any dollar amount, term or condition you don't understand. Don't sign a loan agreement if the terms differ from what you thought they would be. For example, a lender should not promise a specific APR and then - without good reason - increase it at closing. If the terms are different, negotiate for what you were promised. If you can't, be prepared to shop elsewhere.

Get a copy of the documents you signed. They contain important information about your rights and obligations.

Don't initial or sign anything saying you're buying voluntary credit insurance unless you want it.

Having second thoughts about the loan? The Truth in Lending Act gives most home equity borrowers at least three business days after closing to cancel the deal. This is known as your right of rescission. To rescind, you must notify the creditor in writing.

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