Potential Dangers of Home Equity Loans

Home equity loans are basically the same as a second mortgage. The bank or loan company lends you money up to an amount roughly equal to the equity in your house. Equity is the difference between the market value of your home and what you owe on it.

Most consumer credit counselors do not recommend these kinds of loans because they have significant dangers and drawbacks. The first and foremost danger is that you put your most valuable possession, your home, at risk. Think of the possibility that your children could be without a home in the future if you are not able to pay the loan.

Keep in mind, that there is a wide difference in interest rates. Current rates vary from about 8 percent to almost 23 percent. While the interest is tax deductible, don't expect unrealistic tax savings. If you use the loan for luxuries, you may lose tax advantages.

Because these loans are "fully collateralized, which means your home value almost always exceeds the debt, lenders may make these loans without being sure the borrower can afford to pay. You, the borrower has less protection in the event of default. It is easier to foreclose on a second mortgage than on a federally insured first mortgage, such as a FHA or VA mortgage.

Following are cautions if you decide to shop around for these loans:

• Watch out for low introductory rates, especially on revolving credit lines. Your loan rate may start at 6 percent, but 4 months later increase to 12 percent. The loan rate may be variable, based on the prime rate in the future. You have no way to predict future prime rates. Many variable rate loans have no cap on how high the interest rate may go. As a general rule, consumers should avoid loans without "caps" or with "caps" higher than they can afford to pay, no matter how low the current rate.
• Watch out for points and closing costs that could total several hundred dollars.
• Watch out for balloon payments. That means by a certain date a large sum of money is due. If you can't pay the balloon, you lose your home.
• Also, beware of loans packed with unnecessary or expensive life insurance, property insurance, or credit insurance. Buying credit or disability insurance cannot be made a condition of getting a loan. Property insurance can be required, but can always be purchased through your own insurance company.

Don't accept ads at face value. Always shop around for credit. There are many different types of products, rates and lenders. Remember what's at risk with home equity loans -- your home.

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