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Finding the Right Home-Equity Lender

Author: Andrew Taylor

If you need to raise money – and you have significant equity in your home – a home-equity loan or home equity line of credit (HELOC) may be the most cost-effective way to acquire it. Since it's a secured loan, you are likely to get the most favorable interest rate that your credit score allows and you can deduct the interest rate on your taxes, if you itemize your deductions.

Types of Loans

Not all home-equity loans are created equal. There are actually two types: a traditional home-equity loan and a home equity line of credit (HELOC). A home-equity loan is similar to a mortgage in that you get a loan and immediately begin repaying it for a set amount of time (read Home-Equity Loan vs. HELOC: The Difference). A HELOC functions more like a credit card in that you have a certain amount of money available that you can borrow as you need it. In fact, some lenders will give you a debit card that's attached to your HELOC.

Finding a Traditional Lender

Most people will use a traditional lender for their home-equity loan. Good news: If you're using a traditional lender, new regulations going into effect on October 3, 2015, will make it easier to compare offers. In the past, you received a good faith estimate but lenders had a lot of latitude in the way they could break down the costs of the loan, which made offers difficult to compare. The new loan estimate document clearly lays out the costs of the loan, allowing for easier side-by-side comparisons. (See Home-Equity Loans: The Costs.)

Shopping for a loan from a traditional lender – a bank or mortgage company – depends on the amount you're seeking. Generally, for loans under $100,000, a small community bank or credit union will offer the best deal. For larger loans ($150,000 or more), talk to local and national banks along with mortgage brokers. As with traditional mortgages, mortgage brokers can often offer the best deals on home-equity loans because of their relationships with multiple lenders and investment pools. For "in-between" loans of $100,000 to $150,000, "you just have to shop," says Casey Fleming, mortgage broker and author of "The Loan Guide: How to Get the Best Possible Mortgage."

If you already have multiple accounts at a bank, ask there about better rates or special promotions for existing customers.

Know What You're Getting

First, never talk to only one lender. Lenders charge wildly different rates to use their money. You need at least three options, and you might also need the help of a mortgage professional to help you compare the offers.

Second, don't forget about your number-one goal when procuring a loan: You want to pay the least amount possible over the life of the loan. Estimate how long you will hold the loan and calculate how much you will pay over that time. If you plan to hold the loan for 15 years, add up the closing costs and monthly payments over that time period. The lender with the lowest total costs is probably the one you should go with.

Third, don't get too hung up on the Annual Percentage Rate (APR). Pay attention to the APR as a point of comparison only if you intend to keep the loan for its full term," says Fleming. "Otherwise, it's meaningless."

The whole point of the APR is to help you understand the tradeoff of upfront costs against the interest rate," Fleming continues. "However, the analysis is run assuming you are going to keep the loan until maturity, whether that means until it's paid off or until a balloon payment is due. Generally, paying more up front for a lower interest rate will yield a lower APR. But if you pay off the loan earlier than that, the math is totally different. You haven't had enough time to save on interest to pay for the additional up-front costs. In this situation, a total cost over the estimated holding period is much more meaningful."

Finally, make sure the loans you're comparing have the same terms. As Fleming points out, A 30-year loan is not the same as a 15-year loan due in 30, which has 30-year amortization but a balloon payment due in 15 years.

Other Loan Types

If you're okay with pursuing options outside the traditional mortgage lending markets, there are a few routes to consider.

Peer-to-Peer Networks. Peer-to-peer lending networks make home-equity loans. One of the most popular peer-to-peer lenders is LendingClub. Some people like these loans because of the lack of complicated and expensive application processes. In most cases, you won't have to pay for a home appraisal or sign mountains of paperwork. (See Peer-to-Peer Lending Breaks Down Financial Borders.)

The downside of peer-to-peer loans is the lower loan amount. LendingClub offers home improvement loans up to $35,000. Prosper, another peer-to-peer lender, also offers up to $35,000. If you need more, this option probably won't work for you.

Peer-to-peer lenders still check your credit worthiness by considering your credit score. The higher your score, the more favorable your interest rate.

Online Lenders. There are also online lending companies such as LightStream. A division of SunTrust Bank, LightStream offers loans that don't require complicated paperwork. If you have excellent credit, you can receive your funds as quickly as the day you apply. LightStream calls it an AnythingLoan because you can use it for any home improvement project you would like without pledging your home as collateral. Loans start as low as 3.99%. Unlike peer-to-peer lenders, LightStream allows you to borrow higher amounts – up to $100,000.

Zero-Percent Credit Cards. Paying for, say, a renovation with a new credit card with a 0% introductory rate might work if you need a relatively small amount of money for a short amount of time. Typically, you will get the 0% rate for only 12 to 18 months (at which point it will increase), and you certainly don't want to be stuck paying high credit-card interest rates for a home improvement. So this type of loan is appropriate only if you know that you can pay it off before the 0% rate expires. Even then, it is probably a last resort.

The Bottom Line

Most people will use traditional mortgage lending markets to secure a home-equity loan or line of credit. If you do, get multiple offers and consider asking for help from a mortgage professional before making a choice. If you're looking for a smaller amount (less than $100,000), a community bank, a credit union, or a less-traditional lender will likely offer the best deal with the lowest closing and loan origination costs. Remember that a home-equity loan or line of credit puts your home at risk if you are unable to pay off the loan, so use it only if you're confident that this won't be a problem.

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