| Home Equity Loan Pitfalls |
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The home equity loan came of age in 1996 when changes in the tax law eliminated
deductions for the interest on most consumer purchases. Interest paid on home
equity loans, however, remained exempt, up to $100,000 for taxpayers filing
jointly.
The two main types of home equity loans are fixed-rate loans
and variable-rate lines of credit (called HELOCs). The terms for both range from
five to 15 years. With fixed-rate loans, the monthly principal and interest stay
the same. Adjustable-rate loans usually start at a lower interest rate?#8364;”meaning a
lower monthly payment?#8364;”but can climb to a predetermined cap based on market
conditions.
Most banks and mortgage companies are happy to make home
equity loans because the loan is secured by a tangible asset that can be seized
and sold to satisfy the debt if necessary, which minimizes their risk. But the
ease with which homeowners can cash out their equity?#8364;”sometimes up to 125% of the
value of the home?#8364;”brings with it certain pitfalls.
Reloading
Home equity loans are appealing to people who have fallen into a downward
spiral of spending and borrowing. The cycle of getting a loan to pay off debt
and free up credit that is then use to make additional purchases is called
"reloading."
Reloading leads to accelerated borrowing that can result in
homeowners getting upside down on their home loans, e.g. owing more than the
home is worth. The loan is no longer fully secured by collateral and if the
borrower's income goes down or the home's market value plummets, the owner could
face foreclosure or bankruptcy.
People who consolidate their credit card
bills or car loans into a home equity loan are transferring unsecured debt to
secured debt and putting their home in jeopardy.
Home Equity
Scams
Another pitfall is predatory scammers. The Federal Trade
Commission warns about, "Unscrupulous lenders (who) target older or low-income
homeowners and those with credit problems. These lenders may offer loans based
on the equity in your home, not on your ability to repay."
Avoid lenders
who tell you to falsify information on the application, e.g. saying your income
is higher than it is to qualify for the loan.
Avoid lenders who don't
provide the required loan disclosures or who tell you not to read them; or those
who won't give you copies of the documents they want you to sign.
Avoid
lenders who promise one set of terms when you apply, and give you another set of
terms to sign; or who ask you to sign blank forms, saying they'll fill in the
blanks later.
Don't let anyone pressure you into using your home as
collateral to borrow money you may not be able to repay. If you can't make the
payments, you could lose your home.
On the Plus Side
A home
equity loan does have some pluses. Compared to other forms of borrowing, it is
easier to get, comes at a lower interest rate, and has tax advantages that other
loans don't. It can help borrowers clear up outstanding bills while leaving them
with a single monthly payment at a lower rate of interest. True, this doesn't
reduce debt, but it can restructure it in beneficial ways.
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