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5 tips for smart borrowing

By Liz Pulliam Weston

Here's how to know if you're getting a good deal:

Compare the rates. The rate you'll be offered on a loan or line of credit depends heavily on your credit score -- perhaps too much, according to one banking regulator. Julie Williams, acting head of the U.S. Comptroller of the Currency, said in December that home-equity lenders were relying too much on "risk factor shortcuts" like credit scores, which reflect consumer's past credit performance but that don't factor in how well they'll handle a big increase in their debt.

If you have an excellent score of 760 or above, you should be able to win a home-equity line of credit for half a point below the prime rate, said Chris Larsen, CEO of E-Loan. A good score of 700 to 759 should win you a rate equal to prime. (To see current rates on lines of credit and loans by credit score, visit the Loan Savings Calculator at People with mediocre to poor credit can pay 1 to 5 points over prime, or more.

Avoid the fees. If you have decent credit, you shouldn't have to pay any application or appraisal fees to borrow against your home. (Make sure the lender isn't tacking fees onto the loan amount, and that you're not paying a "broker fee" if a third party is helping to arrange the loan.) You may have to pay recording fees, which should be minimal, and an annual fee on your credit line.

Know the tax rules. Home-equity borrowing is often touted as superior to other consumer debt because you can deduct the interest. But that's not always true. You have to be able to itemize, which most taxpayers can't do because they don't have enough deductions.

If you have excellent credit, for example, you might be able to get a new car loan for a fixed rate that's actually lower than what you'd get on a variable line of credit. Unless you're able to itemize, the fixed-rate auto loan is clearly the way to go.

Also, know that even if you do get a deduction, the tax break is limited to interest on loan amounts of $100,000 or less; if you've borrowed more, the interest you pay on amounts over $100,000 can't be deducted.

Know what you're risking. A home can be a good way to build long-term wealth -- as long as you're not constantly draining it away. Every dollar of equity you borrow is a dollar that can't be used to buy your next home when you're ready to trade up, or to fund your retirement when you're ready to downsize.

Be particularly wary of using home equity to pay off credit cards or other short-term debt. Often you'll just wind up deeper in debt because you haven't addressed the basic overspending problem that got you into trouble in the first place.

Also, don't assume that using equity to pay for home improvements or education is always a slam dunk. Not all home improvements add value and it's easy to go overboard with student-loan debt, as well. It's up to you to set reasonable limits on your borrowing and to make sure that what you're buying is worth the wealth you're committing.

In general, you don't want the term of your borrowing to last longer than what you've purchased. If you use home-equity borrowing to buy a car, for example, try to pay off the balance in a few years -- and definitely before you trade in for a new vehicle.

Keep some headroom. You should try to keep a cushion of at least 20% equity in your home. If your combined mortgage and home-equity borrowing exceeds that amount, you'll pay higher interest rates. You're also cutting yourself off from an important source of funds in an emergency.

"Very few families are good at savings. In effect, their home equity is their 'rainy day' fund," Analore said. "It's the only source of capital that many people will be able to tap in an emergency. And it won't be there if the home has already been leveraged to fund short-term consumption."

Choosing the Right Home Equity Loan Option


Are you bewildered by the staggering number of loans designed to let you tap into your equity? The options seem endless, but they don't have to be "too much of a good thing." The first step toward choosing the right home equity loan option is deciding how you want the money. The following loan choices are described in terms of whether you want money in a lump sum (ideal for short-term needs like home improvement projects or a vacation), or smaller, incremental withdrawals (perfect for college tuition payments).

Cash-Out Refinancing-Lump sum

If you're looking for a lump sum of money, and rates on first mortgages are low, the cash-out refinance is a great call. This involves refinancing your first mortgage and cashing-out a lump sum of equity. In this case, closing costs are higher than with a second mortgage. However, if rates for first mortgages are lower than what you currently hold, you could wind up with a hat trick: A lower monthly payment, long-term interest savings, and the cash you need. With a hat trick like that, your financial life won't be skating on thin ice.

Home Equity Loan-Lump sum

The home equity loan has a fixed rate and term, and, like its sister, the home equity line of credit (HELOC), is considered a "second mortgage." Because first mortgages must be satisfied "first," if a bank is forced to sell a house because of a loan default, lenders charge a slightly higher rate for second mortgages. However, if your first mortgage is at a low rate, the home equity loan might be just the ticket for a lump sum cash withdrawal.

Home Equity Line of Credit (HELOC)-Incremental withdrawals

A HELOC, like the home equity loan, carries a higher interest rate than a first mortgage. It's a popular choice for people who are looking to tap their equity for regular payments that spread out over time. Borrowers who need to make college tuition payments choose HELOCs because they work in a similar manner to credit cards: You have a pre-set credit limit, which you may draw upon when you need it. You're only charged interest on the amount you tap, and the rate is generally tied to the prime lending rate, which is relatively stable.

These are the three most popular ways to transform the equity in your home into cash. All you need to do is decide whether you want a lump sum or incremental withdrawals. Once you make that choice, refer to the general guidelines listed above. It should narrow down the vast universe of lending options to a home equity loan that meets all your needs.

The 5 worst ways to spend your home's equity

For most of us, our homes is the most valuable thing we own. Thatâ??s why our experts urge you not to spend or risk that savings:


As ridiculous as it may sound, people have used home equity lines of credit and put the roof over their heads at risk to finance a gambling trip to Las Vegas and to buy lottery tickets. You might as well set a match to your money or flush it down the toilet and then spend the next 10 years paying for it with interest. We won't make any moral judgments here about gambling, but suffice it to say that you should never gamble more than you can afford to lose. We think it's a safe bet that the vast majority of people can't afford to lose their house.

Buying speculative investments.

If it sounds too good to be true, it probably is, right? Keep remembering that every time you think about using your house as collateral to play the stock market, invest in secret, new technology or buy a race horse. The risk associated with speculative investments is incredibly high. The same rule applies here as for gambling: Don't invest more than you can afford to lose.


Vacations are wonderful things. They're an important part of life. But there's a much better way to finance a vacation than borrowing money from a home equity line. It's called saving. Yes, it takes longer but while you're saving, your money is actually earning interest instead of you having to pay interest while paying back a loan. And your trip will be that much sweeter knowing that it's completely paid for.

Paying for a wedding.

According to statistics from the wedding industry, the average cost of a wedding these days is around $26,000. Are we the only ones who think that's insane? Why would you spend that kind of money on a party? But, to each his own. If you have the money and all your other financial ducks are in a row, then knock yourself out. But footing the bill with a variable-interest loan that puts your house at risk? This is one time to say, "I don't."

On luxuries you can't really afford -- especially depreciating assets.

Yes, it would be wonderful to drive a (fill in the name of your dream car) or have a membership at an exclusive, private country club. But financial responsibility requires living within your means. If the only way you can afford to pay for things is by borrowing money from your home equity line, you really can't afford them. As it relates to vehicles, they start losing money the minute you buy them, so don't put an asset that increases in value (your home) to finance one that loses value (a car, a boat, a recreational vehicle, etc.) Far better to secure those loans with the item itself. Then, if something happens and you can't make the payments, the bank will take back the vehicle and not your house.

By Pat Curry Contributing Editor

How To Save Thousands Of Dollars On Your Home Mortgage

By:Randy Johnson

  1. Lenders are a lot smarter than you about mortgages. To improve your odds, you need to get an education, (like reading my book) to develop the power you need to negotiate a better deal.

  1. Get your credit report with credit scores and correct any mistakes before applying

  1. Do not simply call a bunch of lenders and ask, "What are your rates?" Many lenders quote programs which are designed specifically to snooker the telephone rate shoppers. It will "sound good" because it was designed to "sound good." Some loan reps purposely lie to phone shoppers in order to induce borrowers to apply with them. You are not smart enough to catch them.

  1. Your objective is to find a lender you can trust. You'll find such a person through referrals from your friends, co-workers, and neighbors who are homeowners, not the Yellow Pages. You want to find a Loan Rep who will help you and, if needed, "go to the mat" for you.

  1. Determine which loan program is best for you. As an example, do not pay for 30 years of expensive rate protection (what the 30 year fixed rate loan does) if you are only going to be in your home for 6 or 7 years.

  1. Beware of "Zero Point" or "Zero Cost" loans. They are sucker loans. Nothing is free!

  1. Your lender is legally obligated to send you the RESPA and Good Faith Estimate of Closing Costs within 3 days of application. Insist on this! Read them and ask questions until you understand them. While this disclosure is not binding on the lender, it will show the costs and fees on the program on the date you applied, a good starting point.

  1. You need to find out your lender's lock policy. They probably won't lock until you tell them to. The market can change rapidly so developing an executing a good lock-in strategy is very important.

  1. Make sure that if the market improves while your loan is in process, your lender passes 100% of the benefit of the improvement in rates to you.

  1. Refinancing -- obtaining a new mortgage to replace an existing one -- can save you big money, but not in the way you think. Do not go back to another 30 year loan even though the payment is lower because you can actually end up paying more. Keep the same payment you now have and it will reduce the term of the loan, saving you tons of money.

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