What's the least-known way to loseyour home? Taking out a homeequity loan that you can't pay back, andhaving the lender seize your house.
Millions of Americans—includingdebt-plagued young physicians—couldface that danger down the road if thepresent trend continues. They're loadingthemselves with debt they might not beable to repay, grabbing inexpensive,easy-to-get home equity loans and linesof credit to pay off big credit card balances,bills, cars, and vacations. Then,more than 90% of them go back andmax out their credit cards all over again.
"It's a calamitous situation,"saysPaul Richard, executive director of thenonprofit Institute of Consumer FinancialEducation (ICFE; www.financialeducation-icfe.org). "Home equity borrowersare spending their hard-earnedequity."Also, if a person files for bankruptcy,the bank can foreclose on thehouse, because, in all but 5 states, itisn't protected under the law.
GROWING EQUITY ISSUE
Home equity borrowing and refinancingare rapidly growing. One expert saysthat for every person who refinanced in1990, 93.8 people did so in 2002.Homeowners borrowed $130 billion instraight home equity loans last year alone,bringing the total to about $400 billion.Home equity lines of credit account foranother $250 billion.
Paying it off:
A home equity loan is just like a secondmortgage. You borrow a set amount,based on your equity in the house, at afixed rate for a specified number of years(ie, 5 to 30). A home equity line of credit,on the other hand, works just like a creditcard and has a variable rate that changeswith the bank's prime rate. When you make a payment, your creditline revolves back up.
It's fair to say that home equity borrowinghas many pluses. The interest rateis about half that of a credit card (currentaverages are about 4% to 14%). In addition,the interest cost is usually tax-deductible.You get thousands in fast cashwhen you need it, and, if the money isrepaid promptly, you can improve yourcredit score. Plus, you can wipe out creditcard bills and other debts overnight.
But the average homeowner doesn'tmanage their money for the long haulvery well. Hence, they face the prospect offoreclosure. There could be unforeseenproblems such as a sudden illness in thefamily or a money crunch that wouldimpair their paying off the debt. Also,with a line of credit, their introductoryrate could jump dramatically.
BREAKING BAD HABITS
"More than 90% of the people whouse home equity to pay off credit cardsgo right back and run up big card balancesagain,"says Sam Hohman, presidentand CEO of Credit Advisors Foundation."Within 18 months they've usedup what they borrowed. It's a questionof habit, and people must change."Paying off credit cards with home equityfunds is a smart idea, Hohman adds, "butafter that they should limit themselvesto using only 1 credit card."
ICFE's Richard declares that "Thebiggest danger to home equity loans isthat homeowners are betting their housethat they won't ever have a problem makingthe payments. And the integrity ofmany lenders is eroding."
Always shop around for severallenders'rates and fees, read all the fineprint, and be on guard against lenderswho know you can't repay from thebeginning. When you fall behind, theycould use this as an opportunity to refi-nance the loan, which only pushes youmore deeply into debt and chips away atmore of your equity. When you fail to pay,they foreclose and end up buying theproperty at bargain-basement prices.
Robert K. Headyis the founding publisher
of "Bank Rate Monitor."He welcomes
questions or comments at jrnl8888@aol.
com or PO Box 14875, North Palm Beach,