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Unhappy Ownership |  Home Equity Loans  |  Basics of Homebuying

Be Careful with Home Equity Loans
By Holden Lewis /bankrate.com

Spring is the season when homeowners shake the money trees that they live in.
It's the time of year when people borrow against the equity in their homes: One-third of home equity lines of credit are opened from April through June as borrowers seek cash so they can fix up their houses.

But people don't spend their equity solely on home improvements. They use home equity loans and lines of credit to pay off credit card debt, to buy cars, to cover the kids' tuition and to pay for vacations. Now that the season for tapping equity is upon us, it's a good time to ask two questions: What are proper and improper uses for home equity debt? How much home equity debt is too much?


First, definitions: A home equity loan is a lump sum that you get when you take out a second mortgage. An equity line of credit acts like a credit card, allowing you to withdraw money as you need it. When you pay principal, the credit revolves and you can use it again.

"With home equity loans, you're placing your home on the line," says Rudy Cavazos, spokesman for Money Management International, a debt-counseling agency with offices in 10 states. "If you default on this loan, you could lose your house."

Cavazos says you have to ask yourself a few questions before getting an equity loan or credit line. The first is to evaluate all the options, including selling things you don't need and borrowing against one's 401(k).

Second, he says, shop around for an equity loan or line of credit. Compare interest rates, fees and rate caps.

Next, ask yourself what will happen if something bad happens.
"Come up with contingency plans and scenarios," Cavazos says. "How about if my spouse loses her job? What if we become ill for more than 30 or 45 days? Do we have short-term and long-term disability insurance? You've got to think of all these things."

Cavazos refuses to judge the wisdom of using equity to pay for things such as weddings and vacations. So does Jessica Cecere, president of Consumer Credit Counseling Service of Palm Beach County. People get into debt trouble because they borrow too much to pay back, not because they spend on the wrong things.

When people ask if they should tap their equity, Cecere answers that it depends on their self-discipline and financial savvy: "Does it make sense tax-wise? Or do you find yourself habitually in debt, and this is the way out?"

Both Cavazos and Cecere said they are leery about equity lending programs that allow homeowners to borrow up to the value of their homes, or even up to 125 percent of the value of their homes. In the latter case, someone with a home worth $200,000 could have up to $250,000 in debt backed by the house.

"You really shouldn't be in a position where you could be upside-down on your house," Cecere says. "That's really scary."

Anthony Hsieh, president of HomeLoanCenter.com, an online lender that underwrites home equity loans and lines of credit, said he disagrees. Some borrowers are perfectly capable of borrowing up to or more than the value of their homes, he says. His bank approves high loan-to-value lines of credit only to people with excellent credit histories and sufficient income.

Hsieh said he believes that equity loans and lines of credit might actually keep some people out of bankruptcy. He says some homeowners get equity lines of credit while they have jobs, just so they will be able to tap those credit lines like "a giant emergency credit card" if they lose their jobs. After all, when you're unemployed, it's too late to apply for a loan.
On the Net: www.bankrate.com/brm/green/loan/loan3b.asp      www.moneymanagement.org