We’ve all seen the ads: happy couples frolicking on a beach or climbing Machu Picchu all because they decided to turn to home equity loan lenders for the cash to make it happen. But before you cross something off your bucket list using the equity in your home, we want you to consider what you could be risking.
While a home equity loan does allow you to borrow money against your house to get some quick cash, there are home equity loan risks that rear their ugly heads — particularly in the long-term. If you are not financially stable or have limited employment opportunities, you may want to hold off.
Differences Between a Home Equity Loan and a Home Equity Line of Credit
Before we really delve into home equity loan risks, we need to separate two concepts that people often think of as interchangeable: home equity loans and home equity lines of credit. Here we’ll outline some of the main differences because they are by no means the same, even if they do share similar terminology.
Home Equity Loan (HEL)
A home equity loan is essentially another mortgage that borrows against the equity in their home, most often at fixed rates.
- You get a lump sum of money
- The interest rate is fixed
- Repayment of the loan is done in monthly installments and includes principal and interest
Home Equity Line of Credit (HELOC)
A HELOC is when you open a line of credit, similar to a credit card, and is established ahead of time how much and how often you use it. But unlike a credit card, your home is used as collateral; meaning if you fail to pay your debts, you will lose your home.
- You have an open line of credit for 10 years
- The interest rate is variable
- Lower monthly payments during the 10 year draw period – after that, you pay principal and interest
The Most Common Home Equity Loan Risks
1. Home Equity Loan Lenders Could End Up Owning Your Home
You’re putting your home on the line by using it as collateral when you take out a home equity loan, so it is not a decision to be taken lightly. You need to know that if you enter into a home equity loan agreement you are at risk of losing your home if you are unable to pay back the loan in full and on time.
Before taking this step, determine whether or not you have the resources to repay the loan – and that includes fees and interest. It’s a mistake to think of the equity in your house as a cash source that can be accessed as easily as hitting the ATM. You should think of a home equity loan as a second mortgage.
Home equity lenders are in the business of making money. One of the ways they do that is to initiate foreclosure proceedings if you default on your loan. The more equity you have in your home, the more likely they are to foreclose because there is usually money left over for them to recover after the first mortgage is paid off.
Before you enter into such an agreement, you need to be sure that you are financially stable enough to pay it back.
2. You Are At the Mercy of Interest Rates
Typically HELOCs have adjustable interest rates. This means if rates go up, your repayment cost will go up. Of course, the reverse is true, but it’s quite a gamble. Try working with the lender to negotiate a fixed rate for a specified period of time during the draw. That way you will be protected if rates increase, at least during the time span in which your rates are locked.
3. Home Equity Loan Lenders Can Make Minimum Payments Attractive
It might seem very attractive to be able to access cash so easily, but many will tell you this is a fool’s paradise. Once you’ve spent the lump sum on what you need, you’re only left with making those pesky payments.
Just like a credit card, minimum payments, while attractive, will never pay off your debt. This is why lenders make paying the least amount possible so easy.
4. Home Prices Go Up – And They Go Down
Most homeowners assume the longer they live in their houses, the more its value increases. That’s called appreciation. This may be true much of the time, but it’s wise to remember the lessons of the housing crisis a decade or so ago. Housing prices tanked and a lot of homeowners ended up in homes that were worth less than what they owed on them.
If you’re going to borrow money against your home, we advise you not to borrow more money than you actually need and pay your loan off as soon as possible. If you’re not sure how long you’ll be living in your home, borrowing against the equity in it could be very risky.
5. There Can be Points, Fees, and Penalties
You have to take additional costs into consideration. You should have a clear understanding of how many points you will be charged. (1 point = 1% of your loan amount. For example: If you borrow $10,000, 1 point is $100.) Traditionally the more points you pay, the less interest you pay. Most lenders charge between 1 and 3 points. If you are being quoted a higher number, you should ask why.
You will have to pay an application fee that may or may not be refundable if you’re turned down for the loan. Lenders and brokers may charge fees, or points that can be added to your loan, have to be paid at closing, or both. Lenders often charge fees for late or missed payments. You need to know if there are prepayment or refinancing penalties.
Why SKYDAN Equity Partners Is a Better Alternative
If you’re experiencing financial problems and your credit has suffered, you may have a difficult time getting a bank to give you any kind of loan. SKYDAN is different. We don’t require a credit check in order to help you get back on your feet and avoid foreclosure.
SKYDAN isn’t a bank, mortgage company, or lender. We are a real estate investment company that partners with homeowners wanting to take advantage of their home equity through our sale and leaseback program. When you work with us, you don’t have to worry about your credit score, or making mortgage and interest payments.
Just 4 Easy Steps
- Qualify: You can qualify with no income, and poor credit.
- Home Visit: We’ll set up an appointment to evaluate your property within 3 – 5 days.
- Qualify Funds: Based on the value of your property, we’ll determine how much cash you qualify for within 7 – 10 days
- Payment: You can have up to $250,000 cash in your pocket within 30 days. (Property value determines actual amount)