Published 12 May 2019
Thinking of purchasing a new vehicle or installing an in-ground swimming pool? Perhaps you’re in need of cash for college tuition, mounting debts or an extreme makeover for your family pet. Maybe you’d like to improve your home by remodeling or adding more space. Those uses and more can be financed using a home-equity loan (HEL) or home equity line of credit (HELOC). But is it prudent to use the money — no matter what the circumstance? Maybe. Maybe not.
According to CoreLogic’s Homeowner Equity Insights report for the fourth quarter of 2018, “U.S. homeowners with mortgages (roughly 63 percent of all properties) have seen their equity increase by a total of nearly $678.4 billion since the fourth quarter 2017, an increase of 8.1 percent, year over year.” The report also revealed that the average New Mexico homeowner gained $9,000 in equity during the same period.
While the upside of borrowing against the equity in one’s home can be highly beneficial under the right circumstances, the downside of tapping home equity is that a person could ultimately lose their home. That’s why great care should be taken when deciding whether to even tap your equity in the first place, not to mention making sure that the money will be used for a good purpose.
Before we explore how these products can be best used, let’s first define the term equity. Equity is the difference between the market value of a property and the amount owed against it. For example, let’s say a Las Cruces area homeowner owns a property valued at around $200,000. After deducting the $125,000 owed on the first (and only) mortgage, the $75,000 difference represents the homeowner’s equity. If the property had no mortgage, the equity would be the full $200,000.
A home-equity loan is essentially a second mortgage. A HEL can also be a first mortgage if it is the only loan against the property. The “number” assigned to a mortgage (i.e., first, second, third, etc.) is determined by the order in which the mortgage document is recorded at the county recorder’s office. With a HEL you receive a lump sum of cash and pay it back in fixed monthly installments over a fixed term, just like a traditional mortgage loan. The most common length of the HEL is about 20 years.
Typically, a home-equity loan is best used for one-time goals for which payment will be due in full and which has long-lasting benefits. Funding a home improvement that adds value and more equity to your home is a good example. Another reason to tap the equity in your house might be to pay off high-interest loans or credit card balances. Doing so may not be such a good idea, however, if you turn right around and load up your credit cards again. Such folks are referred to by the credit industry as credit card abusers.
In contrast, a home equity line of credit provides homeowners with the opportunity to tap into their equity without being obligated to borrow the money. Instead, it lets you borrow only the amount you need when you need it. The HELOC also provides borrowers with more repayment options and only requires that you pay interest on the amount of money you’ve taken. With the actual loan, you pay interest on the full amount you borrowed – whether you’re using it or not. HELOCs are also good for short-term financing needs that arise unexpectedly. This line of credit is also a good choice for people who own their homes free and clear of any other loans, enabling them to access ready cash by simply writing a check against their equity.
Both loan types come in fixed and variable rate versions. On average, rates for both HELs and HELOCs hover around the nation’s prime rate. The prime rate is the rate at which banks lend to their most creditworthy customers. Obtaining your HEL or HELOC from a reliable source is also important, according to the folks at the Federal Trade Commission.
According to a recently released FTC Consumer Alert, “you could lose your home and your money if you borrow from unscrupulous lenders who offer you a high cost loan based on the equity you have in your home.” The consumer alert points out that certain lenders target homeowners who are elderly or who have low incomes or credit problems — and then try to take advantage of them by using deceptive practices. According to our nation’s top consumer protection agency, here are a few methods unscrupulous lenders use to bilk customers:
Loan flipping: This practice encourages homeowners to repeatedly refinance their loan, often to borrow more money. With each refinance, the lender charges additional fees and interest points — which simply increases debt.
Insurance packing: Here, lenders add premiums for credit life, health and accident insurance to the loan, which may not be wanted or needed by the borrower.
Bait and switch: In this scenario, the lender offers a consumer a particular set of loan terms and costs at the time of application, then pressures the borrower to accept higher charges when it’s time to actually sign the loan papers.
Equity stripping: Here, the lender makes a loan based on the equity in the property rather than on the borrower’s ability to repay the loan. If the borrower can’t make the payment, he or she could end up losing his or her home.
Nontraditional products: It is not uncommon for lenders to offer loans in which the minimum payment does not cover the principal and interest due, causing the balance of the loan and monthly payment to eventually rise. This type of loan, when coupled with a variable interest rate, can cause monthly payments to skyrocket if interest rates rise.
Deceptive loan servicing: In this instance, lenders fail to provide an accurate or complete account statements or loan payoff information. This practice makes it almost impossible for a borrower to determine exactly how much they’ve paid or how much they owe.
The FTC also suggests that borrowers ask for an explanation of any dollar amount, term or condition that is unclear.
Federal law is very specific about what credit and loan term information must be provided in writing before consumers apply for a loan or sign any agreements. Additionally, the FTC suggests that consumers learn more about equity loans by contacting banks and credit unions in their area. They further advocate that consumers speak with someone they trust before making any decisions or signing any agreements.
If you think an unscrupulous lender has taken advantage of you or someone you know, or if you wish to learn more about deceptive lending practices, contact the FTC directly. They’re easy to reach at www.ftc.gov or by phoning (877) FTC-HELP (1-877-382-4357).
See you at closing!
Gary Sandler is a full-time Realtor and president of Gary Sandler Inc., Realtors in Las Cruces. He loves to answer questions and can be reached at 575-642-2292 or Gary@GarySandler.com.