The Home Equity Trick And Why Those Greedy Banks Love It!

One of the things all banks and lenders love is when a homeowner is willing to use the amount of equity they have in their home as collateral to take out a home equity loan or equity line of credit. That’s because it allows them to minimize their risk as much as possible when lending you their money. If you are considering using equity in the property you own as collateral for a home equity loan or HELOC then just make sure it’s for the right reason. Too many families (millions of them in fact) have taken these kinds of loans and squandered them on frivolous things only to regret it years later or worse still, face into a foreclosure. What a nightmare.

Now don’t get me wrong, there are many circumstances when using home equity makes perfect sense and is 100% the right thing to do, just make sure that you understand the difference between a good loan and a bad loan. That’s one of the things I’ll be talking about right here.

In recent years banks have enjoyed spreading the gospel (the good news) about home equity. The basic pitch is that you’re sitting on a little gold mine called home equity and perhaps don’t even realize it. This little gold mine can help you get access to funds which you can use to buy the things you’ve always wanted. These things could range from a pleasure fishing boat to a world cruise… and guess what? The fashion for this access to cheap easy cash has caught on. Home equity products have become the most profitable and fastest growing of all consumer loans in the marketplace.

Borrowing on home equity loans and lines of credit is now bigger than what we owe on credit cards at around $720bn and has quadrupled in the last 5 years. Those figures don’t include the subprime mortgage lending market – some of you may be surprised to know that actually the vast majority of home lending in the subprime market is through home equity loans and HELOCs.

Here’s Why Banks Love Home Equity Lending

The reason is because it offers them one of the lowest risks among all consumer lending products. If we take credit cards for example banks will typically lose around 3%, with home equity loans it’s just 0.15%. You see, the bank doesn’t really have to deal with a “bad debt” where real estate is involved in most cases. It you and your home which is at stake so its more likely you’ll do whatever it takes to make the repayments.

Equity loans have a lower default rate which makes them appear like a more positive kind of loan to take but actually its an illusion. Here’s where the real problem is - too many borrowers are squandering their long term asset wealth in place of short term spending… and the banks are letting them. The blame lies partially in people not understanding some basic principals about maintaining your financial health but also that the banks are willingly letting people make bad refinance decisions. For example, taking a home equity loan to add an extension to you house which in turn will increase its value in the marketplace is one thing but taking a HEL to fund a years travel to the far east is another… it should be common sense.

The Range Of Home Equity Products

Only rough statistics exist but it’s estimated that up to 33% of all home-equity borrowing is used to purchase things which will quickly depreciate in value such as vacations, cars & boats and credit card debt consolidation. What these loans should really be used for are to make solid investments in things like education (college loans) or to substantially improve your home which will actually increase the value of your property.

When considering taking some home equity product offered by a lender you should take the necessary time to fully understand how to best use them so you don’t create a bad loan or something which actually takes your wealth and erases it with home equity debt. With home equity loans, you’re betting your house. Lenders can and WILL foreclose on your house. Even though it’s technically a second mortgage, the law gives them the right to foreclose upon your home.

There are two main types of home equity lending and you can read my reports about them here – home equity loans (HEL) and home equity lines of credit (HELOC) where you can have revolving credit. You should also investigate reverse mortgage programs as they are related to this area of lending.

Tips When Applying For A Traditional Home Equity Loan Or Line

1. The thing uppermost in anyone’s mind is going to be home equity loan rates of interest. Here’s the thing… the interest rate you’re offered on an equity loan will be calculated substantially upon your credit score. This approach has been criticised by experts in the industry as while it can be an honest indicator of your past credit history it can’t accurately tell lenders about how you’ll deal with a new and quite sizeable debt being introduced into your life. The typical time frame for these kinds of loans are 5 to 15 years and may be at a fixed or variable rate of interest with monthly payments. The current state of the housing market in your area will also be taken into consideration.

Generally speaking, an excellent credit score of more than 760 will get a HEL at a fixed interest rate which is slightly below the prime rate. A poor credit score will see you pay anywhere between 1 to 5 points over and above the prime rate. That’s just the reality of it and all part of mathematical risk assessment.

2. With any kind of home equity credit your property will need to be evaluated by a licensed and approved professional in order to ascertain the fair market value of your home. There are application fees (such as recording fees, origination fees and appraisal fees) involved in applying for these loans and an initial insurance premium but if you have a respectable credit score then you should expect that your bank will waive some of these for you. Make sure that your home equity loan fees aren’t being simply tagged onto the loan itself!

3. Watch out for tax. It’s true that home equity loans or mortgages carry tax benefits where borrowers can deduct the interest on repayments but don’t just take it at face value – check everything out with a qualified accountant as there are specific things you’ll need to do in order to meet the requirements.

4. With any home equity loan make sure you’re adding to your wealth with some of solid investment which will grow and give you a return with time. Be especially cautious if you’re using it for credit card debt consolidation. That is a once only get-out-of-jail card. If you continue to use your credit cards irresponsibly and refuse to change your spending habits you’ll only end up in even more debt and may even lose your house.

5. Shop around and let lenders know you are shopping around to compare home equity loans. This is the number one most important thing you can do and will give them an incentive to offer you the best deals they have. Come prepared having done your own sums on an online home equity calculator and with a list of questions such as “What would happen if I decided to lease my home during the term of the loan?” Try to think of every eventuality.

Related Information

Home Equity Loans – “Home Equity Loans – The Must Know List Before You Apply!”
Home Equity Lines of Credit – “The Stark Reality Of Home Equity Lines Of Credit (HELOCs) Today”
Home Equity Lenders – “Come Prepared Or BE Prepared To Be Taken Advantage Of”