Bills.com Outlines 5 New Rules of Home Equity for Homeowners
As banks begin to extend loans to good credit customers, drawing on equity can be a savvy move with proper planning and careful consideration.
SAN MATEO, CALIF. — March 09, 2011 — A recent Smart Money report chronicled an increasing willingness on the part of banks to extend home equity loans and a resulting rise in home equity borrowing. For those good credit homeowners who still retain equity in their homes, this can be a powerful way to eliminate other forms of debt or finance needed projects.
"The return of home equity lending is a positive sign for the economy and a relief for many homeowners searching for ways to reduce credit card debt or finance a renovation," said Virginia Sullivan, VP of Consumer Education at Bills.com. "However, it is no longer the panacea that it once was — only the best credit customers will qualify and homeowners need to carefully consider the long-term implications of rising rates and inflation."
To help identify the right time and ways to use home equity loans, consumer money resource Bills.com today issued its Five New Rules of Home Equity.
1. Learn the Home Equity Basics
Make sure you learn the fundamentals of home equity before jumping into the fray. There are two basic types of home equity products — a home equity fixed-rate loan and a home equity line of credit. Identify the one that is right for your needs based on the loan parameters and long-term implications.
A Home Equity Fixed Rate Loan is a fixed rate second mortgage dispensed as a one-time lump sum with a typical repayment term of 5-15 years. Despite a higher rate than a variable rate home equity line of credit, a fixed rate loan affords homeowners a consistent payment and protection against rising interest rates.
A Home Equity Line of Credit (HELOC) is a variable rate loan tied to the Prime Rate. Funds can be drawn on as needed, and are usually interest-only payments for a set period of time, at which point they become fully amortizing payments. This means that homeowners must be prepared for a significantly higher monthly payment when it converts. The advantage of a HELOC is that it can have a lower interest rate than a fixed line, and you only draw as much as you need.
2. Evaluate the Impact of Inflation, Interest Rates, and Home Value
Many homeowners will greet the return of lending positively, but they must understand how changing inflation, interest rates and home values could impact a loan before signing on the dotted line. With mortgage interest rates continuing to hover around historic lows, it is likely that rates will increase over the coming year. Given that HELOCs are variable interest rate products, this should be of concern to potential borrowers and they must plan accordingly. As rates increase, so will payments - leaving homeowners on a budget in a predicament.
Similarly, there is some concern by economists regarding the potential for rising inflation. Homeowners should factor in the impact of a weaker dollar on their ability to cover an additional mortgage note, especially a variable interest rate loan. Finally, with a broad housing recovery still uncertain, homeowners should be wary of possible continued drops in home value. By removing equity from their home through a home equity line, homeowners will be particularly vulnerable if values continue to decline.
3. Evaluate the Risks of Secured Versus Unsecured Debt
On the surface, it may sound compelling to pay off your outstanding credit card debt using a home equity loan in order to save money on higher interest rates. But homeowners should carefully evaluate the long-term implications and risks of paying off unsecured debt using secured debt. Unsecured debt in the form of a credit card does not place your belongings - such as a car or home - at risk as collateral, while a home equity loan secures the balance using your house as collateral.
So for those on a tight budget looking to reduce payments, paying off high interest rates cards using a HELOC can be a great trade-off with immediate benefits. However, if circumstances change and you are no longer are able to afford your payments, your home could be at risk. Carefully evaluate your budget and the potential for rising rates. It might also make more sense to pursue a fixed rate loan to eliminate the possibility of rising payments over time.
4. A Home Equity Loan Is Not Protected in a Foreclosure
Homeowners should carefully research the math and long-term affordability of a second home loan. Unlike a first mortgage loan, a home equity product is not protected in the event of a foreclosure. This means that even though the primary loan on the home is removed through the foreclosure process, the home equity product remains in force. A foreclosure then will result not only in a lost home and a damaged credit score, but it will also leave the homeowner with an active loan note on a property they no longer own.
5. Home Equity Loans are No Longer Easy Money
Simply because banks are once again extending home equity loans does not mean everyone will qualify. Homeowners should first understand how much equity they have remaining in their home after the recent nationwide slide in home values. Generally, banks will still require at least 20 percent equity in a home. Potential borrowers should also expect to meet strict minimum eligibility requirements that normally include a 720 credit score and verified income for the past two years.
For more information about home equity loans, please visit the Bills.com Web site or the Bills.com Home Equity Loan Resource. To ask a direct question of a Bills.com financial expert please click Ask Bill.