The Home Equity Loan Zone

If you’re considering a second mortgage home equity loan, watch out for Mortgage fraud. Mortgage fraud is one of the fastest growing white collar crimes in the country, adding to over $1 billion a year in losses.

Aggressive lenders often persuade unsuspecting homeowners to participate in their fraud, putting them at risk for fines and/or jail sentences. Their most common prey are sub-prime borrowers – i.e. people with low incomes and/or weak credit ratings.

So, if you want to stay out of jail, watch out for the common warning signs of mortgage fraud. Be skeptical and don’t just automatically believe everything your lender tells you. You don’t want your need or desire for a second mortgage get in the way of your judgment. Play it safe. Double check with your state regulating agency if something smells fishy.

Misrepresenting yourself on a loan application is probably the most common mortgage fraud. Lying on a loan application constitutes mail or wire fraud, which is punishable by fine and jail time. Therefore, don’t ever over exaggerate your income or home value or under report your personal debt on a loan application. Also don’t ever be conned into using an Employer Identification Number or EIN to create a new credit identity. It’s also against the law.

Every line on your application form should be filled by you. Don’t leave any lines blank or allow the loan agent to change any information. Deceitful lenders have been known to add fraudulent information to applications. But, ultimately, you’re signing the form and totally responsible for its accuracy.

In all your excitement and nervousness, don’t let anyone rush you through the closing process. Before you sign the contract, make sure your loan amount is not more than your home’s appraised value and that you’re not being charged any unexpected fees. Also check that your monthly payments are what you expected them to be and that there is no clause that forces you to pay “daily interest” for any reason. In other words, read the small print.

Lenders may also try to sell you credit insurance. They may even imply that purchasing credit insurance is a requirement of your contract. It’s not illegal for them to do this, but it is highway robbery. Credit insurance is very expensive and very difficult to cancel once you sign the agreement. But it is your choice to purchase credit insurance or not. No one can force you to buy it.

One final point. Beware balloon payments that often go along with low monthly and interest only payment plans. Balloons are extremely risky. Many borrowers are losing their homes to foreclosure because they didn’t have a fail-safe plan to get out of their balloon when it came due. So don’t get yourself into a balloon loan unless you know exactly what you’re doing.

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.

It’s time for Home Equity 101. But, don’t worry, it’s not a difficult subject, so you should be able to ace the course. However, what you do with what you learn can, in the long run, effect your life more than your entire grade point average.

Let’s begin with the basics. Your home is worth a certain amount and you probably have a mortgage for part of that. For example, let’s say your house appraises for $250,000 and your mortgage is currently for $200,000. The amount you owe on the loan ($200,000) subtracted from what it’s worth on the open market ($250,000) adds up to the equity you have in your home. In this case your home equity would be $50,000.

See how easy it is? But here comes the tough part. What are you going to do with that $50,000 equity you have in your home? Are you going to keep it there in case you ever have some kind of emergency or want to sell your home and have something left over? Or maybe you even like the idea of paying off your mortgage entirely so you own your home free and clear and no longer have the monthly overhead.

But, then again, maybe you want to take out a home equity second mortgage or a home equity line of credit to be able to access that $50,000. There are lots of reasons you might want to have your hands on that money. Possibly for something like credit card debt consolidation, medical expenses, a college education for your children, taking a vacation to somewhere you’ve always wanted to go or just to have more cash on hand to spend when you feel like it.

However, and here’s the tough part to consider, if you do that, you’ll use up all the equity in your home. And that puts the roof over your head in a shaky position. If anything should happen and you couldn’t cover the extra mortgage payments, the top would blow off of your home investment and you’d no longer have the security of a roof over your head.

So, now that you know the basics, it’s time to see if you have the common sense to make a good, sound, grown-up decision about your home equity.