The Home Equity Loan Zone

Home equity loan (HEL) ads are all over the place. It seems everyone is touting them as “the perfect way to consolidate debt.” And many people are responding. Between 1997 and 2004, according to Federal Reserve statistics, home equity loans and home equity lines of credit jumped from $416.2 billion to $826 billion. Actually, home equity loan debt is now far greater than credit card debt. Apparently, the ads work, but do home equity loans work?

Of course, you can switch high interest credit card debt for far lower home equity rates and even, possibly, get the chance to deduct on your state and federal incomes tax some of the interest you pay. But aggressive lenders fail to warn homeowners of the serious risks involved with home equity loans.

The most serious questions you need to ask yourself before getting into a home equity loan is “Will I suddenly now be able to control my spending and manage my money effectively? Or am I just going to max out my credit cards once again after I pay them off?”

Well, no matter how good your intentions are, the chances are you won’t clean up your money act. Very few people do. In a recent survey done by Brittain Associates, an Atlanta research firm, nearly two thirds of homeowners who consolidated their debt with home equity loans just ran up their credit cards once again in two years.

And many of these home equity loans were made to people already under financial stress because of low incomes and/or bad credit. Ten years ago, in a much more conservative mortgage market, most of these “subprime” borrowers would not have been considered creditworthy by lenders. They wouldn’t have qualified for a loan, even if they did put up their home as collateral.

But, in todays much more competitive and aggressive mortgage industry, it seems like anyone with some home equity can borrow against it, no matter what their income or credit status is. Depending on who you are, this liberality can be either good or bad.

It can be good, if you have the discipline to manage your spending habits. However, if you don’t have the discipline, you could end up losing the roof over your head. And, if you don’t believe the risk of foreclosure is serious, consider this. Foreclosures are on the upswing from coast to coast. In some states, like California, they’ve actually doubled in the past year.

And debt consolidation home equity loans to less than prime borrowers is a major cause of this increase in foreclosures. Subprime mortgage loans are very risky. At any one time, about 16% are delinquent and over 4% are in actual foreclosure. These default numbers are predicted to go up even higher in the near future.

Why? Because, in order to keep their payments down, many subprime borrowers chose to go with low introductory adjustable rate mortgages. As these ARMs revert to higher fixed rates over the next couple of years, some of these borrowers are going to see their monthly payments increase by as much four or five hundred dollars, which is more than they can probably handle.

If you’re thinking about getting a home equity loan to consolidate debt, you better be smart and be careful. They only really make sense if you’re absolutely confident you’re not going to just run up more debt all over again. And most conservative financial advisors don’t recommend HELs for consolidating debt. Instead, they believe home equity loans should be used only for such things as capital home improvements, emergency medical bills and educational expenses.

There are lots of other safer ways to pay off your credit card debt, so think twice before taking a home equity loan. That is, if you want to keep the roof over your head.

Mortgage brokers don’t work for banks, nor do they lend money. They work as independent free-lance agents. They may have a working relationship with more than one commercial bank, savings and loan association, investment bank or private lending source.

Brokers work as go-betweens, bringing borrowers and lenders together for a fee. Their fee may be paid by the borrower, the lender or even a combination of the two. The point is brokers have their own agendas and work in their own interest as well as yours. Still, you may get a better dealing going through a broker than you would on your own.

Mortgage brokers will work with you and the lender through the whole mortgage loan process. They’ll take a look at your specific needs and desires and evaluate your particular circumstances - equity, income, credit standing, etc. - with the intention of finding you the best lender for your situation.

You could do all this yourself, but a broker will save you the time and hassle. And, since they work with various lending companies, they may be able to get you a better mortgage with lower interest and improved terms, especially if your local bank denied you a loan or you’re having other problems getting a mortgage. Brokers can often find lenders for applications some banks refuse.

If you decide to set up a meeting with a broker, always take along all of your necessary information, including copies of your credit reports. This will help get the whole process off on the fast track. The broker will have a clearer picture from the start of you and your particular situation. It’ll also provide a better idea of the type of loan and terms that would be best for you.

Finally, always do your homework. Read all the ads and check out all your options. Before choosing a mortgage broker to work with, get referrals from someone you know or ask the potential brokers to provide references. Local real estate agents might be willing to recommend brokers they know and respect. You might also get a better deal if you work with more than one broker. That way they’ll be competing for your business and a little competition always works to your benefit.

Using the equity in your home as collateral for a loan to pay off unsecured credit card debt may be a good idea. It’ll probably get you a lower interest and some tax benefits.

But home equity loans are not without risk. If you’re unable to control your spending and just max out your cards once again, you could end up losing the roof over your head. So it might be to your benefit to consider other options first.

Actually, if you’re in debt, the best place to start digging out is to stop spending. Financial self-discipline can do wonders if you’re in money trouble. Hide your credit cards for a while and begin paying for purchases only in cash. And, if you can’t afford something, don’t buy it. At least not now.

A second option is to find a credit card with a low “fixed” rate. Make sure it’s not one with a low introductory rate that’s just going to go up in three to six months. Then transfer your other credit card balances to this less costly card.

Another excellent option is to pay off higher interest rate cards first. For example, let’s say you have three cards and only $100 to put towards paying off your debt each month. Make only minimum payments on the lower interest cards and apply the rest of your available cash to the higher interest card. As soon as you pay off that card, repeat the same process with the other two cards. This is one of the most highly recommended ways to get out of debt.

And, finally, if you’re so deep in debt it’ll take you five years or more to pay your way out, a home equity loan may be your best option. Because of lower interest rates and tax benefits, it would most certainly help lower your cost of borrowing.

But be on your toes, because there are a lot of predatory lenders out there willing to promise you anything – low monthly payments, low interest rates, no credit checks, no appraisals, you name it – just to get their hands on your home equity. They’re a major reason why foreclosures are at record highs all across the country.

If you decide to go with the equity loan option, make sure you do your homework first. Read all the ads and check out all your options. Get as many mortgage offers as you can to compare the fine print. And, if you’re hot sure what you’re doing, get some help. Ask a knowledgeable friend or relative you can trust to go over the details of your mortgage before you sign any papers.

Be safe rather than sorry and you can probably pay off your debts, save some money and keep your home – your most valuable asset.