Home equity loans can be a relatively inexpensive way to finance big-ticket projects like home renovations, debt consolidation, or college education. But as with most types of loans, there are costs to consider. Many home equity loans come with additional fees that can make your loan significantly more expensive than you might expect from the interest rate alone. Here are some of the most common and what you can do about them.
Key points to remember
- Home equity loans use your home as collateral, so they’re less risky for the lender (and cheaper for you) than unsecured personal loans or credit cards.
- In addition to interest, home equity lenders typically charge fees, which can significantly increase your total cost of borrowing.
- Some lenders will waive or reduce certain fees to earn your business.
- If the lender offers to roll your fees into the loan amount, you’ll still have to pay them, and with interest.
What is a home equity loan?
A home equity loan is a loan secured by the equity you have accumulated in your principal residence. Your equity is determined by subtracting the amount you still owe on your mortgage from the current market value of your home. As you make mortgage payments, you build equity by reducing the balance you owe. If your home goes up in value, it also adds to your net worth.
With a home equity loan, you receive a lump sum from the lender which you then repay over an agreed period of time, usually five to 30 years. The longer the repayment term, the more interest you will pay in total. Home equity loans usually have fixed rather than variable interest rates.
Since home equity loans are secured by your home, they tend to have significantly lower interest rates than unsecured debt like credit cards or personal loans.
But interest isn’t all you’ll pay. You will also have to deal with an assortment of fees, whether you pay them upfront or they are built into the loan and paid over time.
If your lender can’t or won’t waive all fees, try negotiating a lower interest rate instead. Lenders usually have some flexibility in term, interest rate or fees.
Common costs and closing costs
Home equity loans generally have similar fees to conventional mortgages. Among the most common are:
- Expert fees. The lender will hire a professional appraiser to inspect your home and estimate its current market value. The house you bought a few years ago may be worth a lot more now, increasing your available capital. A home appraisal will normally cost between $300 and $500.
- Credit application fees. The lender will review your credit reports with one or more of the major credit bureaus to see how you are using credit and how reliable you are in paying your bills. Lenders will also check your credit score before considering offering you a home equity loan. Although you can get your credit reports for free once a year, lenders typically charge between $10 and $100 per report when you apply for a loan.
- Document preparation costs. These cover various documents and vary from lender to lender.
- Title search fees. A title search verifies that you are the legal owner of the home and tells the lender if there are any liens on it. Fees range from $100 to $250.
- Application or set-up fees. This is the fee charged by the lender to initiate the loan process. Some lenders do not charge any at all; others charge up to $500.
- Prepayment charges. These are relatively rare for home equity loans, but they do exist. Prepayment charges or penalties are additional charges for paying off your loan before the end of your scheduled term. They’re more common with home equity lines of credit, but worth investigating, just in case.
It’s a good idea to check your credit reports for any errors that reflect negatively on you before applying for a home equity loan. You can request them for free on the official website AnnualCreditReport.com.
Will lenders waive fees?
Many home equity lenders advertise that they do not charge “bank fees”. This could mean that they waive application or set-up fees. They may also absorb certain costs that cannot be waived, such as appraisals or title searches.
Some lenders also offer to incorporate the fees into the total loan amount. While this may save you on out-of-pocket fees at closing, you’ll still end up paying those fees plus interest on them over the life of your loan.
Can your lender use the appraisal from your original mortgage application?
Unfortunately, even if you bought your home very recently, the lender will require some sort of new appraisal. Since equity can change when the housing market goes up or down, your equity may not be exactly the same as it was a few months ago.
How much capital do you need to apply for a home equity loan?
Most lenders require you to have at least 15% equity in your home before you qualify for a home equity loan.
Do you need good credit for a home equity loan?
Yes. Lenders prefer borrowers with at least a “good” credit rating. Some lenders set the minimum at 620, 660, or 680. A higher credit score may qualify you for a lower interest rate on your loan.
Home equity loans are a relatively inexpensive way to borrow, but they are not costless. Borrowers should ensure they receive full disclosure of all charges, including when and how they are to be paid. Talking to multiple lenders – and letting them know you’re shopping around – can also encourage them to compete with each other to offer you a lower interest rate and/or fee.