By Celine Yong
Home equity lenders make money by charging an interest on the loans they make to homeowners. The maximum amount of money these homeowners can borrow is based on their home's equity. Lenders usually charge interest in two ways - fixed rates or variable rates.
The fixed rate refers to the same rate of interest being charged throughout the term of the loan. There is no need to worry about possible interest hikes.Setting aside the same repayment amount each month helps reduce financial uncertainty for homeowners.
An alternative to the fixed loan is the variable loan. Lenders are able to revise the interest charged on loans upwards or downwards in accordance to the prevailing interest rate. The lender only needs to give between 30 and 60 days' notice, depending on the terms in the loan contract, to effect the change. It would be difficult for borrowers to determine what the monthly repayments will be like.
Variable home equity loans therefore appear rather unattractive. However, they are rather useful at times. When is this type of loan beneficial?
Such a loan is beneficial when the economy is fluctuating with a tendency to decline. Interest rates are expected to be revised downwards during the term of the loan. Homeowners on the variable home equity loan will gain from lowered interest charges on their loan. The money you save in an entire year can pay for a family holiday.
You should consider applying for a variable home equity loan when economic growth and home prices have been steadily rising for the past five to ten years and are showing signs of cooling off. This is because a booming economy is likely to plateau or even decline after five to ten years. Central banks commonly use the reduction in interest rates as a tool to boost a flagging economy.
Borrowers could negotiate with the lending institution about switching to a fixed rate loan when the authorities plan to go for a rate hike.
Before you decide on what type of home equity loan to take, make sure you read the loan agreement carefully to understand what your penalty costs are for early termination. This will help you decide if switching to a different loan arrangement halfway is worth your while.
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