I lost an email from someone asking me about a $50,000 home equity line of credit, also known as a HELOC. I hope she reads this.
In general, I am against home owners taking out a HELOC. It wasn’t that long ago that thousands of home owners who had spent their precious equity on a HELOC found themselves in foreclosure. And consequently, with severely damaged credit.
Now that home values have risen, it is not the time to make that same mistake all over again.
Of course, that doesn’t stop the greedy banks from pushing this product.
I will allow that there is the rare valid reason to take out a HELOC, such as when you want to increase your wealth in real estate by purchasing another home.
On the other hand, using your property as a piggy bank is a bad idea.
Reasons NOT to Take Out a HELOC
I am opposed to increasing the debt on your primary residence for the following purposes.
1) Home improvements: If you can’t afford it, wait until you save the cash. Why? Because a $50,000 remodel does not increase your home value by $50,000. You come out behind financially.
On top of that, you pay back more than $50,000 due to the high interest rates.
2) Consolidating debt: This is a big no! You never roll plastic (credit card debt) into your precious real estate. This is one of the worst financial mistakes home owners made in the past. Don’t repeat it.
If you get your credit card shut down, it’s no big deal. If you get kicked out of your house, it’s a very big deal.
3) Education: Take out a student loan if needed. Never pay for school with your house. That goes double for your kids’ education!
4) Vacation: To the loan officer who suggests this, you reply, “No, I am not stupid.”
5) Open for a Safety Net: A HELOC does not make a good safety net. It is quite the opposite. A bank can reduce or shut down a HELOC at any time. The interest rate can go up, often with a lifetime cap of 19%. This does not provide you with financial safety. Create a savings account for safety. Find a secondary source of income for safety.
A Little-Known Fact and a Warning
Most home owners don’t know that if they have a HELOC (or any type of second mortgage that was opened after purchasing the home) and then want to refinance, that HELOC will put them into a higher credit risk category — even if they have perfect credit and a 800 score.
That’s right, you will pay a higher interest rate simply for having a HELOC when you refinance.
We live in an age of instant gratification and entitlement. Listen folks: you do not “need” granite counter tops or a bathroom makeover. Sure, those things are wonderful to have, but exercise patience and save your money until you can actually afford to purchase them.
I’m talking about people using their homes like a piggy bank. Like children in a candy store, they can’t wait to spend their property value on pretty new kitchens, hardwood floors, sunken tubs, sun rooms, and other desires.
This is exactly what happened in the boom years of 2004 to 2006. Home owners were doing cash-out refinances and taking second mortgages called a Home Equity Line of Credit (HELOC) in order to fund wants. Then to their shock and dismay, when values declined, they had no equity left. Their piggy banks were empty. What’s more, when their incomes declined, they could no longer afford the extra payment on the second mortgage.
Now that values have risen in many parts of the country, new stats show that taking cash out is hot again. Home owners are signing for HELOCs and spending their equity on home improvements.
They justify their desires by saying the improvements will increase the value of their homes. That’s a good line that loan officers use in order to sell loans. Unfortunately, the facts don’t support it. Real figures show that what people spend remodeling their kitchen is more than the increased value of their home. The same goes for the other home improvements.
Reality Check: A remodeled bathroom or kitchen is not “an investment.” You don’t get back more money than you put in.
When you can afford to pay cash for an upgrade, then go for it. By all means, enjoy the luxury. But be smart. Don’t repeat the regrettable mistakes of the past. Don’t take out a loan to buy something that is a want and not a need.
Greed has been defined as having an unrealistic expectation. It is unrealistic to think you can take your equity, spend it, then pay interest to the bank that enabled you to take the loan, and come out ahead.
Better to be patient and prudent by saving up cash until you can truly afford that pretty new upgrade you want.
The Home Equity Protection Act, just like it sounds, is supposed to prevent lenders from gobbling up your precious home equity with high fees. It is a law that limits how much banks and other mortgage lenders can charge you. This is especially relevant when the loan is small, such as the popular Home Equity Loan that many home owners use for remodeling or making home improvements.
Now the Consumer Financial Protection Bureau is raising the limit banks can charge you. Makes you wonder who this government agency is really protecting, doesn’t it?
The fee limit for a home equity loan in 1994 was $400. Last year in 2013, the limit was $625. All loan applications received on or after January 10, 2014 will have an increased fee limit of $1,000.
Of course, it is up to the individual bank and lender to decide whether or not to charge the limit. When shopping for a home equity loan, be sure to ask what the fee is. If they say $1,000, you know they are charging the maximum allowed by law. I advise shopping three lenders before deciding.
For a home equity or other small loan, I would look at a mid-size or small local bank, a credit union, and the bank I currently do business with. Don’t make the mistake of blindly taking the first loan offered.
In addition to the fee charged for a home equity loan, you also need to find out the following:
* Is there a prepayment penalty? If so, what are the terms?
* How does the adjustable rate work? What is the maximum the rate can go up to at the first adjustment? At each adjustment thereafter? The lifetime max?
* Is there an annual fee?
For more valuable information about home mortgage loans, please see Mortgage Rip-Offs and Money Savers.
I recommend the paperback copy over the Kindle, because the Good Faith Estimate forms are too difficult to read in the ebook format.
“If you’re considering getting a mortgage, read this to see what’s going on behind the scenes.” Posted November 8, 2013 by Lovelylight, user name