In 1996, when the tax code was changed to stop letting people deduct the interest on most purchases, the home equity loan came of age. The interest paid on home equity loans, on the other hand, stayed tax-free up to $100,000 for taxpayers who file jointly.
Fixed-rate loans and lines of credit with variable rates are the two main types of home equity loans (called HELOCs). Both range from five to fifteen years. With a fixed-rate loan, both the interest and the principal stay the same every month. Adjustable-rate loans usually start with a lower interest rate, which means a lower monthly payment. However, based on market conditions, the interest rate can go up to a predetermined cap.
Most banks and mortgage companies are happy to give out home equity loans because the loan is backed by a tangible asset that can be seized and sold to pay off the debt if necessary. This lowers their risk. But the fact that it's easy for homeowners to cash out their equity—sometimes up to 125 percent of the value of the home—also comes with some problems.
Reloading
People who are in a downward spiral of spending and borrowing may want to take out a home equity loan. "Reloading" is the process of getting a loan to pay off debt and free up credit, which can then be used to buy more things.
Reloading makes people borrow more quickly, which can cause them to be upside down on their home loans, which means they owe more than the home is worth. The loan is no longer fully backed by collateral, so the owner could lose his or her home or go bankrupt if the borrower's income drops or the home's market value drops.
When people put their credit card bills or car loans into a home equity loan, they move their unsecured debt to their secured debt, which puts their home at risk.
Home equity scams are bad.
Predatory scammers are another danger. The Federal Trade Commission says to be careful of, "Untrustworthy lenders go after homeowners who are older, have less money, or have credit problems. These lenders may give you a loan based on the value of your home, not on how well you can pay it back."
Avoid lenders who tell you to lie on the loan application, such as by saying your income is higher than it really is in order to get the loan.
Avoid lenders who don't give you the required loan disclosures or tell you not to read them, or who won't give you copies of the documents they want you to sign.
Avoid lenders who tell you one thing when you apply and then give you something else to sign, or who ask you to sign blank forms and say they'll fill them in later.
Don't let anyone pressure you into using your home as collateral to borrow money you might not be able to pay back. You could lose your home if you can't make the payments.
On the bright side,
A home equity loan does have some pluses. Compared to other ways to borrow money, it is easier to get, has a lower interest rate, and has tax benefits that other loans don't have. It can help people pay off their debts and leave them with just one monthly payment at a lower interest rate. It's true that this doesn't get rid of debt, but it can help restructure it.
Many websites, such as www.homeequitydebtconsolidation.com, offer free quotes and helpful information. It doesn't hurt to find out how much you might be able to borrow, but make sure you weigh the pros and cons before signing anything.
