Home Equity Loans Should be Used Carefully
November 19, 2007
Home equity loans have long been a good way for homeowners to get cash fast. In the not-so-distant past the entire process of getting a home equity loan could be completed in days, if not sooner. One of the greatest benefits to using these types of loans is their versatility. The funds generated by them can be used for virtually any purpose. Homeowners can pay off medical expenses, college costs, credit card balances, etc. Of course, the funds can also be used for other purposes such as vacations, gambling debts, and adding to the end-of-the-month cash flow when income is below expenses.
Things have changed a bit lately. With the housing market woes now facing millions of homeowners and lenders, some lenders are more careful about issuing home equity loans. Those who would have qualified almost instantaneously a year ago may now find the process more challenging. In nearly all cases of home equity loans, homeowners need to be more careful how they use the money they get, if they can get it.
An example of a way to get into financial trouble with a home equity loan is to use the money to pay down on high interest rate credit cards and then borrow more on the same cards. Many people have done this in the past and are now faced with not one payment to make (the original credit card) but two. A home equity loan is, after all, still a loan.
A better choice for these funds is to use them to build up more equity in the home. A home renovation project is a good example of how the money borrowed can actually make a long term profit for you. It can do this by increasing the value of your home and, at the same time, the renovations can make your home a nicer place to live for you and your family.
For those who are inclined to seek out home equity loans or lines of credit, a few tips might help with the process.
If you are legally able to do so, it is always a good idea to shop for the best rates and the best deals. Not all equity loans are the same, some will be much more beneficial and more affordable than others. The only way to know which is best for you is to shop around.
Make sure you understand all of the costs associated with the loan. This might include such things as title search fees, closing costs, insurance fees, appraisal fees, etc. These costs can really add up if you are not careful. Know in advance of taking the loan if the costs are worth the loan itself.
Have some clear idea of what you want to do with the money. If you plan to use the funds for home improvement, at least have some ball park estimates on what the project will cost. If the funds are for college tuition and associated costs, have a good idea of what all of the costs will be. This can help avoid being short, even after the loan is approved.
Keep in mind that most lenders will only allow you to use up to about eighty percent of the value of your home. From this amount you must also subtract what you owe on the first mortgage and other debt instruments attached to the property.
Consumers should be very careful about understanding the rate structure of equity loans. In nearly all cases, home equity loans do not have flat, fixed rates. There may be a teaser rate of a few years, but after that the interest rate will increase and you need to know that you will be able to make those payments.
Payment structures can vary as well. Some lenders use payment structures that include interest and principal while others use interest only. Interest only can be risky should you not be able to pay down the principal. Also, some lenders use balloon payments which can be very difficult for some homeowners to pay when due. Consumers should ask about any penalty fees for late or missed payments as these can be extremely expensive.
Perhaps the most important issue for homeowners to consider before taking out home equity loans or lines of credit is that they will be putting the home up as collateral. If the payments are not made, on time, the lender can foreclose on the home or place severe liens on it.
Do be careful to avoid making the same mistake that some homeowners have recently made. That mistake was to take out home equity loans for any number of reasons. Many of those same homeowners are now facing higher monthly mortgage bills due to ARM resets and having already used their home equity have no safety net for obtaining future quick cash. It is unfortunate, but many of these homeowners who took the cash out of their homes are now looking at foreclosure or bankruptcy. Do not let that happen to you