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There are several home equity loan terms that can greatly increase your loan costs - you need to be aware of these terms, sometimes avoid them, and always negotiate the best deal possible. Terms to be aware of are: a pre-payment penalty, credit insurance, and interest rate increase on late payments.
Even large, reputable lenders often will not verbally point out that some of these terms are in your loan offer. You should always read the loan documents in full and ask about these terms.
Pre-payment Penalty
A pre-payment penalty is a one-time penalty fee paid to the lender if you pay off a home equity loan early. A pre-payment penalty provision in a home equity loan is very expensive and a penalty of 10% of the loan amount is not uncommon. This means that on a loan of $50,000, you could pay $5,000 if you pay off the loan early.
Two situations that result in paying off a home equity loan early are the sale of your home for any reason or the refinancing of the loan. If you think there is even a possibility that you will sell your home before your home equity loan expires, you should consider removing the pre-payment penalty provision from your loan. A pre-payment penalty can force you to keep a high rate home equity loan by making other options such as refinancing even more expensive.
If you ask the lender to remove the pre-payment penalty provision from your loan, the lender may want to raise the interest rate or increase the points paid at closing. An increase in the points paid is often a better option than an interest rate increase. Remember that the points paid is a one time fee where as an interest rate increase has a longer and often greater impact on the loan cost. When you are presented with the specific options available to you to remove the pre-payment penalty, some basic calculations will tell you what is the best option. A pre-payment penalty can be very costly - if you think there is a chance you will pay off your loan early, it is probably best to have this condition removed.
Credit Insurance
Credit insurance on a home equity loan is always optional - ask if your loan includes credit insurance. Credit insurance can include items such as credit life insurance, disability insurance and unemployment insurance. Credit life insurance, one aspect of credit insurance, will pay off your home equity loan if you die.
If you do think you need credit insurance, your lender is probably not the best place to get it. Comparison shop with insurance providers and also consider alternatives such as traditional life insurance - a life insurance policy is usually a cheaper alternative to credit life insurance.
If you do decide to get credit insurance from your lender, ask if the full loan amount is covered by your credit insurance. Financing the credit insurance, which is called 'single-premium credit insurance', makes credit insurance more expensive since you are paying interest on top of the insurance.
Credit insurance can usually be cancelled and fully refunded within a certain period of time if you have already accepted it as part of a home equity loan. Contact your state consumer protection office for more information about cancellation of credit insurance.
Interest Rate Increase in Cases of Default
A loan may have a provision for an increase in interest rates if you miss a payment or pay late. The increased interest rate will apply to the rest of the loan term. This can be a very expensive consequence if for any reason you miss a loan payment.
Try to negotiate this provision out of your loan agreement. You should be able to find a lender that does not require this provision but if you are forced to have it, be sure you understand exactly what triggers this interest rate increase and the affects it will have on your loan payments.
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