Basics of Home Equity Loan Interest Rates

2007-03-08 10:33:40

( Financial )



What are Home Equity Loans?

A home equity loan is actually more of a line of credit. Unlike a standard loan mortgage package where you draw the entire loan amount then pay amortization, a home equity loan allows you to draw smaller amounts depending on your own discretion, until you reach the maximum amount or credit limit.

This type of credit facility is convenient for your immediate needs, such as paying for college tuition, settlement of your credit card obligations or medical emergencies.

Most home equity lines of credit are considered second mortgages, unless you use it to replace or refinance your first mortgage.

Characteristics of Home Equity Loan Interest Rates

You have a specific time period, usually within a few years, to draw on your home equity line of credit. During this draw period, you will pay only the interest. The lender also gives you a grace period to settle the principal, usually a few years after the draw period. Some lenders may require you to pay the principal entirely at the end of the draw period. If you're unable to do
so, you will need to refinance.

Home equity loan interest rates change on a daily basis compared to the annualized rates of standard loans. Because the interest rate is computed on a daily rate rather than a monthly rate, you end up paying more interest under this type of facility. The interest charge is also calculated by multiplying the rate with the average daily balance of your outstanding loan amount.

Because they are based on daily prime rates, home equity loan interest rates are exposed to high possibility of fluctuation. They are similar to adjustable rate mortgages (ARMs) but on a riskier scale. Unlike ARMs, home equity loan interest
rates don't have caps or ceilings, and could easily reach double-digit proportions. So far, only North Carolina has a cap over home equity loan rates.

At best, you can benefit from a home equity loan if you have the discipline to borrow only what you actually need, and to pay the balance as soon as you can.


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