The Home Equity Loan Zone

Home equity loans (HELs) and home equity lines of credit (HELOCs) are aggressively advertised. Many lenders promote using these loans to consolidate unsecured debt. Basically, using the equity in your home this way is a good idea, but it’s not without problems of its own.

For example, foreclosures are on the upswing all across the country. In California, they’ve more than doubled over the past year. And since both HELs and HELOCs use your home as collateral for a loan, you may be putting your most valuable asset at great risk. As the Federal Trade Commission warns “Borrowers Beware.”

A home equity loan (HEL) is a fixed interest lump sum loan offered on a percentage of your home’s equity. The lender expects you to pay off the loan with interest in monthly installments over a specific period of time. That period could be 5, 10 or 20 years.

A home equity line of credit (HELOC), on the other hand, gives a certain amount of credit to draw on for a specific period of time. It’s a lot like getting another credit card. The lender expects you to pay down your debt each month as you would with a credit card. HELOCs usually have variable interest rates. At the end of the loan period, any outstanding balance is due.

Both HELs and HELOCs have the same basic benefits. Since you’re using your home as collateral, lenders are willing to offer lower interest rates than you get with your credit cards. HELs are usually about half as high as a credit card. HELOCs are often a little higher than HELs. Another common benefit is that interest paid is deductible on federal and state taxes. Be sure to check with a qualified tax expert. These deductions have some limits.

No matter how attractive HELs and HELOCs may sound, they’re not for everyone. For example, many lenders, in order to make these loans sound enticing, offer interest-only payments during the initial years of the term that later revert to principle and interest payments. Others have interest-only payments with a balloon payment at the end of the term.

Both of these plans greatly reduce, at least for a while, the monthly payments for borrowers. However, when the rates eventually change or when the balloon comes due, many borrowers suddenly find themselves in financial trouble unable to make their payments.

HELs and HELOCs are also not usually recommended for the elderly on fixed incomes, those with low incomes or poor credit ratings or those people who are just going to run up more debt after they pay off their credit cards. To be safe, you need to have more than enough steady income to cover the extra payments each month.

Be careful before jumping into any kind of second mortgage. Do your homework and check out all your options. Always get a second opinion and be sure you know what you’re doing. You do want to keep the roof over your head, don’t you?