Remember when you debated the advantages and disadvantages of making your leap into the world of home ownership? Perhaps one of the key elements that impacted your decision to leave the ranks of renters was the fact that you would be building equity in your home with each month's mortgage payment—not simply handing money over to a landlord. Equity amounts to the difference between the market value of a property and the amount of the claims held against it. Suppose your initial mortgage on your home amounted to $100,000. Given the upward market value adjustment many properties have experienced over the past five to ten years, your home may now have a significantly higher market value (what your home would typically sell for given comparable properties [size, condition, etc.] in your neighborhood). The amount by which your home's appraised market value exceeds the amount of liens against it, results in the amount of home equity you have accumulated.
The recently hot real estate market in the United States has created a huge prospective market for banks and independent loan companies that are eager to write loans to homeowners based upon their home equity. The loans are offered up as the answer to financing everything from large purchases or home improvement/renovations to college tuition. The Federal Trade Commission (FTC) states that home equity lenders may let you borrow up to 85% of the appraised value of your home less the amount you still owe on the first mortgage.
Many banks extend a home equity line of credit to the homeowner, which allows him or her to write checks (often a minimum of $100) against the home equity amount without the need of a bank approval on each loan (as would be required with personal loans). While the convenience and freedom of such a situation is enticing and difficult to pass up, there are also significant dangers inherent in the situation.
Draws (or each loan written against your personal home equity line of credit) accumulate very quickly. An individual can very easily become caught up in the excitement of making a new purchase or making home improvements and, in a short amount of time, deplete the home equity line of credit. The homeowner is left with the existing mortgage plus a huge amount of additional debt to pay off over the next fifteen years. In addition, many home equity lines of credit are extended with a variable rate of interest, which fluctuates with the prime rate (the rate at which banks borrow money). For those who are uneasy about loans with variable interest rates, make sure your home equity line of credit options allow you to "lock-in" at least some portion of your loan(s) at a fixed interest rate.
Remember, a home equity line of credit isn't free money. You are still responsible for paying the money back in the form of monthly payments with the addition of interest in addition to your original mortgage. Any decision to draw upon your home equity should be thoroughly investigated, discussed, and considered. In assuming the responsibility for a home equity line of credit, you are risking a valuable asset, your home, as collateral on the loan. In the event that you default on either your first mortgage obligation or repayment of any draws on the home equity line of credit, you run the risk of losing your home to foreclosure. So consider the prospect of a home equity loan very carefully. The Federal Deposit Insurance Corporation (FDIC) offers a variety of suggestions for homeowners considering a home equity line of credit:
In addition, the FDIC says to never sign an agreement if:
The FTC also warns never deed your property to anyone without first consulting an attorney, a knowledgeable family member, or someone you trust. Finally, the FDIC notes that if you are using your home as security for a home equity loan, second mortgage loan, or line of credit, federal law gives you 3 business days after signing the loan papers to cancel the deal—for any reason—without penalty.
Remember, there are less than scrupulous lenders just waiting for an opportunity to take advantage of na´ve and/or confused homeowners. You've worked hard to build the equity in your home and it's an element of additional security for you and your family. Educate yourself, be knowledgeable, and protect that equity in the same way you would protect any of your financial assets. When the time comes to draw upon that equity for your family's future, you'll be able to rest a little bit easier knowing you're making a well-considered decision.
As with any financial decisions, consult with a financial advisor or legal counsel before entering into any binding agreement.
Articles are provided for the general interest of our readers. Gerber Life Insurance is not responsible for any content and recommends that you consult the appropriate professional with any questions or concerns you may have concerning any financial or health related issues.