Sep
17


Drawbacks to Home Equity Loans

Saturday, September 17, 2011

When you need a quick source of funds, a home equity loan can be tempting. Done wisely, you can use the lower-interest debt secured by your house to pay off debts with high interest rates, like credit cards. It’s also a good choice if you know exactly how much you need to borrow for a big expenditure like a new kitchen.
Home equity loans aren’t always the best choice for accessing cash. The best use for home equity is to buy things that will contribute to your home’s value, like a needed remodel, or your family’s future income, like a college education. Consider carefully before you cash in home equity to spend on consumer goods like clothing, furniture, or vacations.
The fact that you’re staking your home against your ability to pay off the debt is just the beginning of the potential drawbacks.
Drawback #1: Money doesn’t come cheap
A home equity loan is a second mortgage on your house. Interest rates are usually much lower for a home equity loan than for unsecured debt like personal loans and credit cards. But transaction and closing costs, similar to those for primary mortgages, make home equity loans a pricey — and imprudent — way to finance something you may want but don’t absolutely need, like a fur coat, exotic vacation, or Ferrari.
The average closing costs on a $200,000 mortgage are $4,070.

To compare offers on competing home equity loans, use a calculator that compares fees, interest rates, and how long you’ll take to pay back the loan. Ask your current mortgage lender if it offers any discounts if you get a second mortgage from the same company.
Drawback #2: Early payoff can be costly
Home equity loans almost always have fixed interest rates, so you know your monthly payment won’t rise. Do check to see if there’s a pre-payment penalty — a fee the lender will charge if you pay back the loan early because you sell your house, or you just want to get rid of the monthly payment.
Such early-termination fees are typically a percentage of the outstanding balance, such as 2%, or a certain number of months’ worth of interest, such as six months. They’re triggered if you pay off part or all of a loan within a certain time frame, typically three years. Despite the penalty, it may be worthwhile to refinance if you can lower interest rates sufficiently.
If you want to be able to borrow money periodically, it may make sense to go for a home equity line of credit instead of a lump-sum second mortgage. Although more lenders are charging stiff prepayment penalties for HELOCs too, these are triggered when the line is closed within a certain period, such as three years, not when the balance is paid off. Bear in mind that interest rates on most HELOCs are variable.
The big advantage to a credit line is that you can borrow whatever amount you need as you need money. The big drawback is that the lender can shut off the line of credit if the value of your home falls, your credit goes south, or just because it no longer wants to offer you credit.
Drawback #3: Beware predatory lenders
Some lenders don’t act in your best interest. Theoretically, lenders are supposed to follow underwriting guidelines on appropriate debt and income levels to keep you from spending more than you can afford on a loan. But in practice, some unscrupulous lenders bend or ignore these rules.
Always shop for the best deal, rather than accepting the recommendation of a home-improvement contractor. Some will try to pressure you into taking their loans at above-market rates — and jack up the price if you don’t. According to the U.S. Department of Housing and Urban Development, you should avoid anyone who insists on only working with one lender or who encourages you to do things like overstate your income.
Drawback #4: Your house is at stake
A home equity loan is a lien on your house that usually takes second place to the primary mortgage. As such, home equity lenders can be left with nothing if a house sells for less than what’s owed on the first mortgage. To recoup losses, second-mortgage lenders will sometimes refuse to sign off on short sales unless they’re paid all or part of what they’re owed.
Moreover, even though the lender loses its secured interest in the house should it go to foreclosure, in some states, it can send debt collectors after you for the balance, and report the loss to credit agencies. This black mark on your credit score can hurt your ability to borrow for years to come.
There are benefits to home equity loans. Often you can write off the interest you pay on the loan. Consult a tax adviser to see if that’s the case for you. And the rates can be lower than what you’d pay for an unsecured, personal loan or if you used a credit card to make your purchase.
When you need a quick source of funds, a home equity loan can be tempting. Done wisely, you can use the lower-interest debt secured by your house to pay off debts with high interest rates, like credit cards. It’s also a good choice if you know exactly how much you need to borrow for a big expenditure like a new kitchen.Home equity loans aren’t always the best choice for accessing cash. The best use for home equity is to buy things that will contribute to your home’s value, like a needed remodel, or your family’s future income, like a college education. Consider carefully before you cash in home equity to spend on consumer goods like clothing, furniture, or vacations.The fact that you’re staking your home against your ability to pay off the debt is just the beginning of the potential drawbacks.

Drawback #1: Money doesn’t come cheap

A home equity loan is a second mortgage on your house. Interest rates are usually much lower for a home equity loan than for unsecured debt like personal loans and credit cards. But transaction and closing costs, similar to those for primary mortgages, make home equity loans a pricey — and imprudent — way to finance something you may want but don’t absolutely need, like a fur coat, exotic vacation, or Ferrari.The average closing costs on a $200,000 mortgage are $4,070.

To compare offers on competing home equity loans, use a calculator that compares fees, interest rates, and how long you’ll take to pay back the loan. Ask your current mortgage lender if it offers any discounts if you get a second mortgage from the same company.

Drawback #2: Early payoff can be costly

Home equity loans almost always have fixed interest rates, so you know your monthly payment won’t rise. Do check to see if there’s a pre-payment penalty — a fee the lender will charge if you pay back the loan early because you sell your house, or you just want to get rid of the monthly payment.

Such early-termination fees are typically a percentage of the outstanding balance, such as 2%, or a certain number of months’ worth of interest, such as six months. They’re triggered if you pay off part or all of a loan within a certain time frame, typically three years. Despite the penalty, it may be worthwhile to refinance if you can lower interest rates sufficiently.

If you want to be able to borrow money periodically, it may make sense to go for a home equity line of credit instead of a lump-sum second mortgage. Although more lenders are charging stiff prepayment penalties for HELOCs too, these are triggered when the line is closed within a certain period, such as three years, not when the balance is paid off. Bear in mind that interest rates on most HELOCs are variable.

The big advantage to a credit line is that you can borrow whatever amount you need as you need money. The big drawback is that the lender can shut off the line of credit if the value of your home falls, your credit goes south, or just because it no longer wants to offer you credit.

Drawback #3: Beware predatory lenders

Some lenders don’t act in your best interest. Theoretically, lenders are supposed to follow underwriting guidelines on appropriate debt and income levels to keep you from spending more than you can afford on a loan. But in practice, some unscrupulous lenders bend or ignore these rules.

Always shop for the best deal, rather than accepting the recommendation of a home-improvement contractor. Some will try to pressure you into taking their loans at above-market rates — and jack up the price if you don’t. According to the U.S. Department of Housing and Urban Development, you should avoid anyone who insists on only working with one lender or who encourages you to do things like overstate your income.

Drawback #4: Your house is at stake

A home equity loan is a lien on your house that usually takes second place to the primary mortgage. As such, home equity lenders can be left with nothing if a house sells for less than what’s owed on the first mortgage. To recoup losses, second-mortgage lenders will sometimes refuse to sign off on short sales unless they’re paid all or part of what they’re owed.

Moreover, even though the lender loses its secured interest in the house should it go to foreclosure, in some states, it can send debt collectors after you for the balance, and report the loss to credit agencies. This black mark on your credit score can hurt your ability to borrow for years to come.

There are benefits to home equity loans. Often you can write off the interest you pay on the loan. Consult a tax adviser to see if that’s the case for you. And the rates can be lower than what you’d pay for an unsecured, personal loan or if you used a credit card to make your purchase.





Comments subject to review.
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Estella said
"That is a beautiful shot with very good lighting ." about Women Consider Owning a Home to be a Vital Component of the American Dream
on Sunday, May 12, 2013 @ 9:57 AM

Chris White - Team Leader said
"Unfortunately you are not alone. It's more than an outcry. The powers that be really need to come down harder on Bofa than they already are. Working on these short sale for over 2 years now I've uncovered down right fraud happening on the lenders parts. If they cared more about moving this country forward than protecting their own wallets then they would cut the red tape and approve these short sales in a timely manner. Our team made the wise decision to get BofA loans which were FHA or Freddie Mac backed, approved prior to listing on the market. Then we can list the home as "Price Approved" and close in 30 days. In this instance BofA does a full appraisal, rather than an incompetent "Broker Price Opinion" (nothing against agents but they have no idea how to make adjustments on comparable homes) and then the bank issues an "Approval To Participate" letter which dictates what price we can go on the market and take anything north of 88%. I really do hope your situation improves. " about Congressional Bill to Speed Up Short Sales
on Tuesday, August 30, 2011 @ 9:15 AM

Lisa Zeiner said
"We made an offer 4 months ago to BofA, and have heard nothing. It was a cash offer which is better than the zero money they are collecting now. And since the people don't care they are trashing the place, by the time BofA gets around to it our offer will be gone as the place is a mess!! Septic issues now, garbage being dumnped. All of this could have been avoided if BofA really wanted to correct their cash flow problem and sell these properties in a timely manner. They cry about cash but then do nothing intelligent to fix the problem" about Congressional Bill to Speed Up Short Sales
on Tuesday, August 30, 2011 @ 9:06 AM

Jones Ramirez said
"Thank you for the work you have done into this post, it helps clear up a few questions I had." about How do appraiser’s determine a homes value?
on Tuesday, April 19, 2011 @ 10:07 PM

HollyRobsonf said
"Hey - I am certainly happy to find this. great job!" about Bank of America to Offer Principal Reduction to Underwater Borrowers
on Wednesday, April 13, 2011 @ 6:45 PM