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The cost of a home equity loan is made up of interest and fees. The APR, or annual percentage rate, is the single most important thing to compare when shopping for a home equity loan because it takes into account both interest and fees. The APR, which is expressed as a yearly interest rate, factors in the loan interest rate and all fees paid to obtain the loan. Generally, the lower the APR, the lower the cost of your loan.
While interest is the single biggest cost in a home equity loan, the fee component is also important and will influence the cost of your loan. The fee component has two parts: points and closing costs.
Points are one-time service fees that are paid to the lender at closing - one point is one percent of the loan amount. If you take out a home equity loan for $10,000 and are charged one point, you will pay $100 - two points and you pay $200. The number or points you are charged is determined by the lender, the loan amount, the interest rate, the loan type and your credit rating.
Points are often linked to interest rates - generally, the more points you pay, the lower the interest rate. Since points affect interest rates, paying more points isn't necessarily a bad thing. This of course does not mean that you should be charged an excessive amount of points. Increasing points paid should result in a positive shift in the interest rate.
To allow points to have greater meaning, have the lender express points in a dollar amount. On a loan of $20,000, if you are told you are paying $600 in points, this will have more significance than paying 3 points.
You can generally expect the following items to be included in as part of closing costs: attorney fees, a title search, an application fee, a property appraisal fee, credit report fees, insurance fees, mortgage preparation fees, recording and notary fees. Lending institutions may have different names for these items and some may include different items as part of closing costs. For example, an origination or underwriting fee is charged by some lenders as part of closing costs. The origination or underwriting fee consists of credit report fees, a property appraisal fee and loan document preparation fess.
Closing costs are usually between 2% and 5% of the loan amount. Lenders advertising 'no closing cost' loans are not giving you the full picture - the closing costs have either been financed and you are not paying them up front or interest rates have been adjusted to recover the closing costs.
When you finance the closing costs, you add the closing costs fees to the amount you want to borrow and you pay interest on the total amount. If you finance your closing costs, you must know that you will be increasing the amount you pay in closing costs as you are now paying interest on these charges.
The 'no closing cost' scenario in which your interest rate has been raised to waive your closing cost should only considered if you borrow a small amount and pay it off quickly. In other situations, the higher interest rate often costs you more than the closing costs that have been waived.
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