Financial Answer Center

When you are ready to begin evaluating a home equity loan, there are steps that you should take to make the process a smooth one.

The process consists of two steps:

• Gathering information from potential lenders regarding rates, fees, and loan types
• Determining which loan makes the most financial sense for you

To evaluate which loan makes the most financial sense, you'll need to:

1. Compare the loan fees and costs among your different loan choices.
2. Evaluate if you should pay points (See the section "Understanding 'Points,'" and do a rate versus point comparison).
3. Determine if the interest is tax-deductible (See the section What Can You Deduct on Your Tax Return?)
4. Determine the after-tax cost of borrowing. If the interest is tax-deductible, it reduces the net cost of borrowing.

Procedures Checklist

You've decided to apply for an equity loan. Here are the procedures you need to follow:

• Fill out an application
• Ask your lender if fees can be included in the loan amount
• Your lender will order an appraisal of your home
• Determine what is tax-deductible

We will walk through each of these procedures in detail.

The Application Process

After you have reviewed your loan options and found the package that makes financial sense, it is time to proceed with the application.

If you choose to get a home equity loan with your current lender because they can give you the best deal, you could save money on the fees. And, the process can be smoother since the lender already has information about you. You also may not need to get a new appraisal on your home when you apply for a home equity loan with your current lender. However, this may be a rare occurrence in these days of fluctuating real estate values.

The lender will typically run a credit report. So, it is important that your credit report is in good order and that your mortgage payment record is in good shape.

Fees

Did you know that you may be able to include most, if not all, costs of obtaining a home equity loan in the new loan? Each lender has their own rules, so be sure to ask your lender how it handles the fees. Including the costs in the loan makes it that much easier to go through the process because you won't be required to come up with a lot of out-of-pocket cash. The most significant cost that you can include in the loan amount is the points. Instead of paying them outright, you can finance them with the principal amount. Just remember, there's no such thing as a free lunch! Taking out a bigger loan will mean higher monthly payments.

Lenders must provide people who take out a home equity loan with a reasonable estimate of settlement costs and fees associated with the loan; this is called a "Good Faith Estimate." They must do this within three business days after receiving your application.

Appraisals

As the name "home equity loan" suggests, you must have sufficient equity in your home before you can tap into it! Lenders are not usually willing to lend you more than 75% to 80% of the value of your property (some lenders may lend you more than that, depending on their lending policies, so it is a good idea to shop around); that amount is then reduced by your outstanding mortgage balance. Here's an example.

Let's say your home recently appraised for $350,000. Your mortgage balance is $255,000. You could qualify to take out an equity loan or line of credit of approximately $7,500.

If your home happens to appraise lower than you expect, you may have to wait for the real estate market to improve and your mortgage principal balance to decrease (through your mortgage payments) before being able to get the amount of money you need.