Q: We’re thinking that we don’t want to move forward with a home-equity loan we applied for. We’re pretty far along in the process. My bank has informed us that the loan application has been approved and that documents are ready for us to review and sign electronically.
The lender did an appraisal and a survey of our home. We have been debating whether to go through with the loan or not.
What would be the consequences if we tell the bank that we don't want to go forward with this loan? We're afraid of the interest rate and the doubling of our loan payments when you compare the new payment to our current loan payments. We were trying to pay off some debts with the cash received; but, instead, our debt with this loan would skyrocket.
We don't know what to do and how to pull this off.
A: You didn't give us much to go on (like details on the home-equity loan or your other debts), so we're going to make some big assumptions and answer your question.
Our first assumption is that the home-equity loan you applied for was a market-rate loan and not from a lender that had picked you out for a loan carrying a sky-high interest rate and closing costs.
Frequently home-equity loans are very low-cost loans. This means that the lender may have you pay an application fee and a couple of other fees — but the overall cost is low. Typically, home-equity loans carry a higher interest rate than what you’d pay on a first home mortgage, but you don’t get hit with a lot of other closing costs.
Also, home equity mortgages or lines of credit (HELOCs) usually have shorter loan terms and offer loans at far lower amounts than a first or primary mortgage. First mortgages come with fees for appraisals, loan processing, underwriting, document preparation and many other items, including title company or settlement agent fees and expenses. The fees on a first home mortgage can run up to thousands of dollars.
Home-equity loan interest rates are sometimes expressed as a fixed-rate amount, but the loan might be a variable rate mortgage expressed as prime plus some margin, such as prime plus 2.5 percent. The term may be for five or 10 years, and at the end of that term you have to pay the loan back in full.
At the end of November we took a quick look at a national lender’s website, which revealed the interest rate for home-equity loans ranging between 5.5 percent and 7.5 percent, compared with rates around 4.125 percent for a five-year adjustable-rate mortgage and 5 percent for a 30-year fixed-rate loan.
(Mortgage interest rates advertised are typically for people with the best credit scores, usually 760 or 780, and above. If your credit score is lower, you can expect to pay higher interest rates on all sorts of loans, including mortgages, home-equity loans and lines of credit, and auto loans.)
Assuming you have a good credit score, if the interest rate you are being offered is much higher than these, you might have found a lender that is trying to sell you a loan product that is way above the market in pricing. You should have the right to review the costs and decide whether you want to accept the deal or not.
We think you’re thinking about it the right way, though. Yes, if you take out a home-equity loan you’ll have a greater debt load on your home. On the other hand, if your lender is legitimate and the interest rate and closing costs are competitive, you may be swapping your high interest rate payments for credit cards, home improvements and student loans for a lower interest rate with this lender.
If you’re able to use funds from a low-interest, low-cost loan to pay down high-interest loans, you should be better off financially. You need to look over the details of the home-equity loan offer and think about whether the interest rate and terms are market, if they work for you, and if you can live knowing that if you fail to pay on the loan you could lose your home.
On the other hand, if you can use that money to pay down credit card debt, you should have extra money to pay off the home-equity loan faster. For example, if your credit card debt carries an interest rate of 24 percent and you swap that loan for a home-equity loan at 6 percent, you should save a significant amount of money monthly. If you use that savings to prepay your home-equity loan debt, you’ll pay it off much faster. That’s your “best money move,” as Ilyce likes to say.
Talk to your mortgage lender about your options, and try to get a better understanding about the loan you applied for and how it could affect your other debts. You can always decide not to close on the home-equity loan. Please understand that you should have the right (under your loan documents) to back out before you sign the loan documents, and you may even have the right to back out within three days of the loan closing, which is known as the right of rescission. Good luck.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them through her website, ThinkGlink.com.