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The hazards of some home-equity
loans & associated rates!
What looks like an easy way out of debt could one day put your family out on
the street. Get the facts behind those enticing ads for 125%
home-equity loans before you put your home on the line. By TerrySavage
What looks like a great deal, but could turn out to be the most devastating
financial decision of your life?
It's when you consolidate credit-card debt by taking out home-equity
loans for more than the value of your house, sometimes for up to 125% of
the home's value. Unlike traditional home-equity loans that rely on the equity
you've built up in your home, these loans aren't tax deductible and usually
carry higher interest rates.
By television, direct mail and now by e-mail, lenders are pushing you to consolidate
your credit-card debt by borrowing on your home. Here's the text of an actual
e-mail I received recently:
Consolidate Debt, Refinance Your Home or Put Cash In Your Pocket! We Have Special
Programs with rates starting as low as 2.5% APR 7.22% Special Programs for Self-Employed
Borrowers Previous Bankruptcies or Foreclosures OK!! Debt Consolidation - pay
off high-interest debts and get the cash you need Second Mortgages - get 125%
of your home's value.
The television commercials make it look easy and enticing. A top athlete, like
quarterback Dan Marino, offers you the chance to cut your monthly payments,
pay off your credit cards and take out extra cash to remodel your kitchen or
go on a vacation. But think twice. It's important to understand the risks, as
well as the attraction, of those lower monthly payments.
For some, this is the way to go
For many people, a home-equity loan is indeed the smart way to borrow. The interest
rate is typically lower, and the interest is tax deductible. Plus, home-equity loans are amortized over about 15 years vs. about four years
for credit cards. That means the monthly payment on a home-equity loan is far
lower than a minimum required credit-card payment.
For example, if you owe $10,000 on your credit card at 15%, you'll probably
have a monthly payment of $278. But the same amount owed at 15% on a home-equity
loan that's amortized over 15 years results in a monthly payment of only
$140. The more you owe, the more enticing a home-equity loan looks. At $20,000
in debt in the same scenario, the home-equity loan costs $280 a month, while
the credit card and/or auto debt requires a $557 monthly payment.
The trouble comes when people borrow all their home
equity to pay off their debts, but they haven't learned how to manage their
money well enough to avoid running up credit-card debts and auto-loan debts
again. In fact, the lenders have a name for this process: It's called "reloading."
Then, if the economy slows or one of the breadwinners loses a job, the next
time you get into credit-card trouble, you could actually lose your house.
Statistics from the Mortgage Bankers Association underscore the problem. The
percentage of homes foreclosed in 1998 was 1.16%, about double the rate of the
terrible recession years of the early 1980s, when 0.59% of homes were in foreclosure.
The rising foreclosure rate comes even as bankruptcy rates remain high, with
1.2 million filings in 1999. But as people try to avoid bankruptcy, they're
increasingly taking out home-equity loans to pay off their other bills. As a
result of those home-equity
loans (and new mortgage programs designed to help people buy homes with
down payments of less than 5%), Americans have a lower percentage of equity
in their homes than at any time in history.
Essentially, an unsecured loan
The real kicker comes if you borrow past the value of your home. Unlike home-equity
loans, these loans usually are not considered tax deductible. The law says
that all interest on a first mortgage (of up to $1 million) is deductible. And
interest on up to $100,000 of a second mortgage or home-equity
loan also is deductible. By law, interest on any part of a loan that exceeds
100% of the value of your home is not deductible.
In addition, lenders typically charge higher rates, because you've essentially
taken out an unsecured loan. An unsecured loan means there is no collateral
in case you default on the loan. A mortgage for up to the value of your home
is "secured" by the home itself. Many lenders charge interest rates
seven or eight percentage points higher than traditional mortgages. In some
cases, that's twice what you'd pay for a regular mortgage or home-equity
Don't get fooled by the "special programs" offer mentioned in advertisements
like the one I mentioned earlier, either. They're either introductory loans,
which require large "balloon payments" several years later, or adjustable
rate loans in which the rates -- and the payments -- can increase every year.
As long as the loan is repaid, it's very profitable. And the lenders know that
paying off mortgage or home-equity
loans takes a high priority in a consumer's mind, so the default rate is
far lower than on unsecured credit-card lending.
SMR Research, a financial industry market-research firm, reports that about
30% of all home-equity
loans are sub-prime. That is, these are loans made to borrowers who are
considered a poor credit risk -- the very people most likely to be caught in
the crunch when the economy turns down.
Bankruptcy: the only escape
The greatest danger for those who fall for this pitch is the fact that they've
put their home on the line. If they fail to make the payments, the lender can
force the home to be sold in a foreclosure proceeding. The grantor of the original
mortgage must be paid off first; then the home equity lender collects what's
left from the sale price. And if there's not enough equity to repay the home
equity lender, a default judgment will be entered against the borrower for
the difference. The only escape is bankruptcy.
The generation that went through the Great Depression of the 1930s learned
the hard way not to borrow against the family home. So many people lost their
homes that by 1935, banks categorized 20% of all mortgages as "real-estate
owned" -- that is, foreclosed. But today's homeowners have forgotten --
or never learned -- the lessons of their grandparents. Rising home prices have
tempted homeowners to count home
equity as a source of ready cash. But that kind of home equity borrowing
should only be done as part of an overall financial plan and a disciplined approach
to money management. Otherwise, today's easy way out of debt could one day put
your family out on the street.
Benefits of Low Home Equity Loan Rates
- No Equity required
- Don't need to touch your existing Low Rate 1st Mortgage
- Tax Deductible
- Consolidating Debts will Lower your Monthly Payments
- 125% Second Mortgage
- 1st Time Homebuyers OK
- Poor Credit OK
- No Verification Income Loans
- Self Employed Borrowers OK
- Interest Only Loan Options
- Home Equity Lines of Credit
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