Understanding the Home Equity Loan and Equity Release
The home equity loan and equity release products (sometimes known as home equity line of credit) are both lucrative loans options for lenders. This is why you might often find very tempting interest rates on these two loans products, making them hard to resist. However, a home equity loan or equity release plan (or home equity line of credit) could well be your best borrowing option if you own a home and know how to shop around for a good deal.
Types of Interest Rates
When choosing a home equity loan or equity release plan, keep in mind that there are two types of interest rates: fixed and variable. Both rates are typically based on an index, such as the standard variable rate (SVR), which is the core rate that banks use as a yardstick. This rate is influenced by fluctuations in the Bank of England base rate. Lenders will use this rate or subtract (and in some cases add) a fixed percentage, or margin, from this rate to determine what you will pay in interest.
While a fixed rate ensures that the interest rate will not change during the life of the loan, a variable rate fluctuates when the rate upon which it is based upon fluctuates.
If you choose a variable rate home equity loan, make certain that you find out how much the interest rate can change over the life of the home equity loan or home equity line of credit. Check as well to see if there is a cap that will prevent the loans rate from exceeding a certain amount. You typically would not want your rate to rise more than a maximum of five percentage points above where it started.
Caution: Be wary of super-low rates. Some lenders try to entice borrowers with low 'teaser' rates, which may well be very low for 6-12 months, but which may well then skyrocket once this introductory period expires. To avoid any surprises, make sure you ask what the rate will be over the life of the home equity loan, i.e., once the introductory period is done. In most cases you will revert to the lender’s SVR, but there may be cheaper options out there. Remember to read the small print and don't be afraid to ask questions!
There are three types of repayment options for your home equity loan or home equity line of credit, allowing you to choose the best to suit your needs:
- Pay the interest only in your regular payments, so the balance becomes due at the end of the loan.
- Pay a payment every month to cover the interest and the loan principal, so once the loan is done you won’t owe any money.
- Make overpayments whenever you can afford to; this can significantly shorten the life and cost of the loan or home equity line of credit.
If you can make overpayments on a home equity loan or home equity line of credit then you can save a lot of time and money, but do check that these payments are allowed in the loans terms and conditions. Some loans products, for example, will not allow you to overpay or repay in full early and some may even charge a fee if you try to pay off your equity release borrowings early.
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