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Home Equity Loan 101

What is a home equity loan?

Basically, your home’s equity is determined by taking the value of your home and subtracting any other mortgages or liens secured by the home. A home equity loan is a financial product that allows a borrower to use the home as collateral for a loan. There are two basic types of home equity loans: first mortgages and secondary mortgages. A first mortgage is a loan secured by a home that has no other mortgage against it. It is generally the loan you take out to purchase or refinance the home. A secondary mortgage is simply a loan secured by a home that has at least one other mortgage or lien. Home improvement loans are often secondary mortgages.

Borrower beware

Although taking out a loan using your home can be beneficial, beware of lenders who may tempt you with a loan that you cannot repay. Often, these lenders offer products that carry high interest rates, heavy fees, may be designed in a way that causes you to fall behind on the note, and it may have a large balloon payment come due at the end of the term. If you fall behind, or fail to be able to make or refinance the payment on your note, the lender can take your home by way of foreclosure. Once foreclosure begins, most people never get their homes back. If you are a homeowner with equity, you are a potential target for this type of fraud. Knowing what to look for and how to protect yourself can keep you from losing a home.

Home improvement contracts are another potentially troublesome area. Problems can appear when consumers make large up-front payments to contractors, who in turn do not finish the work or who use materials left over from other jobs.

Protect yourself—and your equity

DO:

  • Shop around–compare loan packages to find the one that meets your specific needs.
  • Get the big picture: look at interest rates and fees, not just monthly payment amounts.
  • Review all the information with a credit counselor before signing.
  • Read the entire contract before you sign.
  • Avoid loans with balloon payments that come due at the end of the loan term.
  • Seek out governmental agencies and nonprofit organizations that have special loan programs.
  • If getting a loan for home improvement, find and work with your own contractor and lender to ensure they are reputable.
  • Know what is in the contract before you sign.

        Consider trading your current home for a less expensive one.

DON’T:

  • Don’t take out a loan made solely on the equity value and not on your ability to make the monthly payments.
  • Don’t sign anything that has blank spaces.
  • Don’t borrow more than you need. Equity can be your greatest asset in your next home purchase.
  • Don’t take out a loan from an unknown door-to-door salesperson.
  • Don’t consolidate your bills by using your home as collateral; try to use other means to consolidate.
  • Don’t judge by the monthly payments alone–consider the total cost.
  • Don’t yield to high-pressure sales tactics.
  • Don’t sign forms written in a language that you don’t understand.
  • Don’t sign a contract if it is not what you expected. Always be prepared to walk away!

 

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