Just about anyone with a computer is bombarded daily with ads promising low payments at low rates, but tapping into your home’s equity can be a lot more confusing than you think. Loan terms can end up costing you hundreds more than the ads promised, and you might sign something that can take much longer to pay off than you expected.
“I always tell people, ’If it sounds too good to be true, it’s not true,’” says Pamela Dubois, a mortgage broker with Carteret Mortgage Corp. “If you go to five companies and they tell you 5 percent, and you call one company and they say 41/2 percent, don’t just go with it. Do your research.”
Before putting your home on the line, make sure you fully understand the terms of the loans. Lots of different loans are available, and homeowners can find themselves overwhelmed by confusing terminology and misleading contracts.
“You have to be very disciplined,” says Doug Duncan, senior vice president and chief economist for the Washington-based Mortgage Bankers Association (MBA), representing 2,700 real estate lenders. “A lot of people don’t have the confidence to say, ’I don’t understand this.’”
Home-equity lines with attractive terms might end up actually costing you more because rates change after a short time or because the loan is structured differently than you thought.
Lenders recommend shopping around for the best rate and terms and writing down the details to make comparison easier.
“If you write it down, you start to see the differences in the offer,” Mr. Duncan says. “It also helps you ask questions.”
Home-equity loans come in two types: term loans or home-equity lines of credit (HELOC), with limits determined by the value and equity of your home.
Lenders will allow you to borrow as much as 75 percent of the value of your home — or more — depending on your mortgage balance.
For example, if your home has an appraised value of $200,000, a lender will calculate the appraised value typically at 75 percent, or $150,000. If your balance on your mortgage is $100,000, you can qualify for $50,000 worth of credit.
Loans can be arranged in a lump sum or as a revolving line of credit using a checking account or credit card that homeowners draw on as needed.
Terms vary, but most lenders require minimum withdrawals or some maintenance fees to keep up the line of credit for the life of the loan.
Typically, customers use the credit to finance college education, for home improvements or to consolidate debt.
It has become a popular alternative to other forms of credit because the interest rates are attractive, averaging about 3.6 percent nationally for a HELOC.
The interest is tax-deductible because the loan is secured by your home.
Establishing a HELOC is similar to applying for a mortgage. Homeowners must pay for a property appraisal and face the same fees as they would on a typical first mortgage, including application fees, points and closing costs.
Plans vary by lenders and can either be fixed or tied to some variable, such as the U.S. Treasury bill rate.
The most important part of the process is understanding the terms of the loan.
Some lenders offer low rates that are only good for a limited time, then increase after a set period of six months or a year. Others set a low rate, then require a balloon payment if the principal is not paid off within a set period, say, 10 years.
If your payment is tied to a variable rate, such as the U.S. Treasury bills index rate, make sure you understand how the process works and how high your payment could go under the worst-case scenario.
“You need to educate yourself and do research before you find a lender,” Ms. Dubois says.
Many homeowners don’t understand how the principal is paid down. Lenders say some homeowners agree to a line of credit that covers only interest and a small amount toward principal.
Make sure your plan is set up so that the payment allots enough toward the balance of the loan to pay off the loan in the required period. Otherwise, you may reach the end of the term of the loan and still have a hefty principal.
“You should not sign a document where you don’t understand where every dollar is going,” says Mr. Duncan. “That’s the biggest mistake people make.”
Predatory lenders have taken advantage of the popularity of home-equity loans, luring customers with offers that are hard to resist. Although most lenders are legitimate, a number of predatory lenders have flourished, taking advantage of borrowers with confusing terms.
Through a practice known as equity stripping, a dishonest lender establishes a line of credit beyond a homeowner’s means, then eventually forecloses on the property, according to warnings issued by the Washington-based National Home Equity Mortgage Association (NHEMA).
Crooked lenders also confuse customers by “flipping” loans — establishing one line of credit, then returning a short time later to offer different terms. Every time a homeowner accepts and renegotiates a new loan, the lender makes money through hefty fees at closing.
Another lending scam homeowners should watch out for is commonly called “packing.” Once a settlement date is reached, homeowners sign documents that include hidden fees and expenses that weren’t previously reviewed.
Those expenses might include additional administrative fees, often hidden in documents at closing, NHEMA warns.
Homeowners need to take the time to read everything before signing.
“You never sign a document where they say, ’We’ll fill this in later,’” says Mr. Duncan. “That’s a red flag.”
Federal law is designed to protect homeowners by requiring lenders to disclose all terms before closing. Under the Truth in Lending Act (TILA), lenders must disclose all variable rates of the contract, including payment due date; any balloon payment requirements; monthly payment schedule, including how it is calculated; all applicable fees; and prepayment penalties.
Request a copy in advance detailing all the terms before closing, and compare it to details on loan documents at closing.
If you’ve already entered an agreement but find out later that the terms are deceptive, you have the right to cancel. The TILA allows homeowners to cancel transactions within three days and mandates the return of applicable fees once the loan is canceled in writing.
The NHEMA and the MBA advise homeowners with complaints to contact state consumer-protection offices or the Federal Trade Commission’s Consumer Response Center (877/FTC-HELP).
Complaints can also be filed online (www.ftc.gov/ftc/complaint.htm).
The Mortgage Bankers Association also maintains a Web site, www.mortgagefraud.com, detailing fraudulent practices and how to handle a claim involving a dishonest lender.
“People need to be prudent. They need to take their time,” Mr. Duncan says.
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