Facts for Consumers from the Federal Trade Commission

Home Equity Credit Lines -- June 1992

Using a credit line to borrow against the equity in your home has 
become a popular source of consumer credit. And lenders are 
offering these home equity credit lines in a variety of ways.
You will find most loans come with variable interest rates, some 
come with attractive low introductory rates, and a few come with 
fixed rates. You also may find most loans have large one-time 
upfront fees, others have closing costs, and some have continuing 
costs, such as annual fees. You can find loans with large balloon 
payments at the end of the loan, and others with no balloons but 
with higher monthly payments.

No one loan is right for every homeowner.  The challenge, then, 
is to contact different lenders, compare options, and select the 
home equity credit line best tailored to your needs.

Be sure to review the home equity contract carefully before you 
sign it. Do not hesitate to ask questions about the terms and 
conditions of your financing. To help you do this, you may want 
to consider the following questions and to use the checklist at 
the end of this brochure. (We apologize that the checklist is not 
available on-line. To obtain a copy of the checklist, please 
request a free copy of the brochure by contacting: Public 
Reference, Federal Trade Commission, Washington, D.C. 20580; 
(202) 326-2222. TDD call (202) 326-2502.)

Is a Home Equity Credit Line for You?

If you need to borrow money, home equity lines may be one useful 
source of credit. Initially at least, they may provide you with 
large amounts of cash at relatively low interest rates. And they 
may provide you with certain tax advantages unavailable with 
other kinds of loans. (Check with your tax adviser for details.)
At the same time, home equity lines of credit require you to use 
your home as collateral for the loan. This may put your home at 
risk if you are late or cannot make your monthly payments. Those 
loans with a large final (balloon) payment may lead you to borrow 
more money to pay off this debt, or they may put your home in 
jeopardy if you cannot qualify for refinancing. And, if you sell 
your home, most plans require you to pay off your credit line at 
that time. In addition, because home equity loans give you 
relatively easy access to cash, you might find you borrow money 
more freely.

Remember too, there are other ways to borrow money from a lending 
institution.  For example, you may want to explore second 
mortgage installment loans. Although these plans also place an 
additional mortgage on your home, second mortgage money usually 
is loaned in a lump sum, rather than in a series of advances made 
available by writing checks on an account.  Also, second 
mortgages usually have fixed interest rates and fixed payment 
amounts.

You also may want to explore borrowing from credit lines that do 
not use your home as collateral.  These are available with your 
credit cards or with unsecured credit lines that let you write 
checks as you need the money. In addition, you may want to ask 
about loans for specific items, such as cars or tuition.

How Much Money Can You Borrow on a Home Equity Credit Line?

Depending on your creditworthiness (your income, credit rating, 
etc.) and the amount of your outstanding debt, home equity 
lenders may let you borrow up to 85% of the appraised value of 
your home minus the amount you still owe on your first mortgage. 
Ask the lender about the length of the home equity loan, whether 
there is a minimum withdrawal requirement when you open your 
account, and whether there are minimum or maximum withdrawal 
requirements after your account is opened. Inquire how you gain 
access to your credit line _ with checks, credit cards, or both.
Also, find out if your home equity plan sets a fixed time _ a 
draw period _ when you can make withdrawals from your account.  
Once the draw period expires, you may be able to renew your 
credit line.  If you cannot, you will not be permitted to borrow 
additional funds.  Also, in some plans, you may have to pay your 
full outstanding balance.  In others, you may be able to repay 
the balance over a fixed time.

What is the Interest Rate on the Home Equity Loan?

Interest rates for loans differ, so it pays to check with several 
lenders for the lowest rate.  Compare the annual percentage rate 
(APR), which indicates the cost of credit on a yearly basis.  Be 
aware that the advertised APR for home equity credit lines is 
based on interest alone.  For a true comparison of credit costs, 
compare other charges, such as points and closing costs, which 
will add to the cost of your home equity loan.  This is 
especially important if you are comparing a home equity credit 
line with a traditional installment (or second) mortgage, where 
the APR includes the total credit costs for the loan.
In addition, ask about the type of interest rates available for 
the home equity plan.  Most home equity credit lines have 
variable interest rates.  These variable rates may offer lower 
monthly payments at first, but during the rest of the repayment 
period the payments may change and may be higher.  Fixed interest 
rates, if available, may be slightly higher initially than 
variable rates, but fixed rates offer stable monthly payments 
over the life of the credit line.

If you are considering a variable rate, check and compare the 
terms.  Check the periodic cap, which is the limit on interest 
rate changes at one time.  Also, check the lifetime cap, which is 
the limit on interest rate changes throughout the loan term.  Ask 
the lender which index is used and how much and how often it can 
change.   An index (such as the prime rate)  is used by lenders 
to determine how much to raise or lower interest rates.  Also, 
check the margin, which is an amount added to the index that 
determines the interest you are charged.  In addition, inquire 
whether you can convert your variable rate loan to a fixed rate 
at some future time.

Sometimes, lenders offer a temporarily discounted interest rate _ 
a rate that is unusually low and lasts only for an introductory 
period, such as six months.  During this time, your monthly 
payments are lower too.  After the introductory period ends, 
however, your rate (and payments) increase to the true market 
level (the index plus the margin).  So, ask if the rate you are 
offered is "discounted," and if so, find out how the rate will be 
determined at the end of the discount period and how much larger 
your payments could be at that time.

What Are the Upfront Closing Costs?

When you take out a home equity line of credit, you pay for many 
of the same expenses as when you financed your original mortgage. 
 These include items such as an application fee, title search, 
appraisal, attorneys' fees, and points (a percentage of the 
amount you borrow).  These expenses can add substantially to the 
cost of your loan, especially if you ultimately borrow little 
from your credit line.  You may want to negotiate with lenders to 
see if they will pay for some of these expenses.

What Are the Continuing Costs?

In addition to upfront closing costs, some lenders require you to 
pay continuing fees throughout the life of the loan.  These may 
include an annual membership or participation fee, which is due 
whether or not you use the account, and/or a transaction fee, 
which is charged each time you borrow money.  These fees add to 
the overall cost of the loan.

What Are the Repayment Terms During the Loan?

As you pay back the loan, your payments may change if your credit 
line has a variable interest rate, even if you do not borrow more 
money from your account. Find out how often and how much your 
payments can change.  You also will want to know whether you are 
paying back both principal and interest, or interest only.  Even 
if you are paying back some principal, ask whether your monthly 
payments will cover the full amount borrowed or whether you will 
owe an additional payment of principal at the end of the loan.  
In addition, you may want to ask about penalties for late 
payments and under what conditions the lender can consider you in 
default and demand immediate full payment.

What Are the Repayment Terms at the End of the Loan?

Ask whether you might owe a large payment at the end of your loan 
term.  If so, and you are not sure you will be able to afford the 
balloon payment, you may want to renegotiate your repayment 
terms.  When you take out the loan, ask about the conditions for 
renewal of the plan or for refinancing the unpaid balance.  
Consider asking the lender to agree ahead of time and in writing 
to refinance any end-of-loan balance or extend your repayment 
time, if necessary.

What Safeguards Are Built Into the Loan?

One of the best protections you have is the Federal Truth in 
Lending Act, which requires lenders to inform you about the terms 
and costs of the plan at the time you are given an application.  
Lenders must disclose the APR and payment terms and must inform 
you of charges to open or use the account, such as an appraisal, 
a credit report, or attorneys' fees.  Lenders also must tell you 
about any variable-rate feature and give you a brochure 
describing the general features of home equity plans.
The Truth in Lending Act also protects you from changes in the 
terms of the account (other than a variable-rate feature) before 
the plan is opened.  If you decide not to enter into the plan 
because of a change in terms, all fees you paid earlier must be 
returned to you.

Because your home is at risk when you open a home equity credit 
account, you have three days to cancel the transaction, for any 
reason.  To cancel, you must inform the lender in writing.  
Following that, your credit line must be cancelled and all fees 
you have paid must be returned.

Once your home equity plan is opened, if you pay as agreed, the 
lender, in most cases, may not terminate your plan, accelerate 
payment of your outstanding balance, or change the terms of your 
account.  The lender may halt credit advances on your account 
during any period in which interest rates exceed the maximum rate 
cap in your agreement, if your contract permits this practice.

For More Information

If you have questions about home equity credit lines, write to: 
Correspondence Branch, Federal Trade Commission, Washington, D.C. 
20580. Although the FTC generally does not intervene in 
individual disputes, the information you provide may indicate a 
pattern or practice that requires action by the Commission.

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