In August 2015, the word was out that the fixed rate home equity loan was on the way out, to be replaced by variable rate Home Equity Line of Credit (HELOC) loans. The reason? A jittery economy, continuing unrest in the housing market and the belief that interest rates are on the way up. What exactly does that mean for home owners and home buyers, who are once again beginning to rebuild equity?
Historical Perspective
Home Equity Loans, also known as second mortgages, have long been a source of comfort for owners because they provide a source of ready cash that can be used for home improvements as well as non-real-estate-related expenses. They are secured loans. As such, they have been relatively easy to obtain for anyone with secure earning ability, decent credit, and appropriate home equity.
Low home equity loan rates made these loans a cheap way to consolidate debt, reduce higher-interest credit card payments, finance a car or help a child in college. Second mortgages have always been somewhat risky, however, and became more so during the financial crises of 2008 and succeeding years.
The Shift — and Why
Several things happened as the housing market improved.
- First, owners and buyers became more confident, and dug out from “underwater” housing conditions.
- Second, lenders and the government eased up to some extent on stringent loan requirements.
- Lenders naturally want to close the books on lower-interest loans as prevailing rates ease up.
- As consumers must begin making higher payments, the incidence of default might increase.
- Lenders become nervous when their risk increases, whether it is the risk of default, or the risk they take in making new loans.
So, last August, both Wells Fargo and Bank of America announced that they would cut their fixed rate equity loan programs. There was justification, according to a spokesman, due to decreasing consumer demand.
Indeed, statistics since the year 2000 do seem to confirm the trend. At that time, approximately 40% of home equity loans were fixed term or closed end variety. Today, that percentage has dropped to about 12%. In addition, new regulations that govern lender disclosures took effect during the third quarter of 2015. Those tightened rules, however, do not apply to the HELOC lending.
Available Alternatives
So, if you have substantial equity in your home, and you want to use some funds for a remodel project, pay off a car, eliminate your credit card debt or simply have a cushion of cash available in case you need it, what are your options today? There are several, according to the experts, and they are still attractive.
Even though the big banks are bowing out of the business of fixed-rate second mortgages, local banks, credit unions and private lenders may still be willing to talk to you. You may pay a premium for the loan, but almost certainly the rate will be lower than an automobile finance company would charge, and also below your credit card interest rate. Your credit limit may also be substantially higher.
Alternative lenders may also appear, especially online, to take up some of the slack. Home owners are urged, however, to thoroughly investigate any such offers, and to always read contracts and know exactly what the requirements mean before agreeing to terms and obligating yourself for monthly payments.
The Promise of HELOCsÂ
Home Equity Line of Credit loans, which function in many ways like a credit card, may well signal the future. And, they offer similar advantages to clients who can use the cash. The difference is that you “draw” the money you need at specific times for specific purposes up to a previously determined limit. HELOC terms vary greatly; some can be written with a “borrowing” period of up to 10 years, after which a “repayment” period can extend another 15 years. Interest rates can fluctuate greatly over time, and because HELOC interest is tied to the prime rate, payments could escalate to a higher-than comfortable amount.
Interest rates will vary also depending on your credit score, and loan application fees and closing costs can run as much as 5-6% of loan value. The national average for HELOC interest rate was 5.2% in January 2016, and it is expected that interest rates will rise during the coming year. The increases are not expected to be dramatic, but there are no guarantees.
Most home equity lenders will consider loaning up to 80% of appraised value. That’s considered “safe” for both sides. So, if your home is valued at $200,000 and your mortgage balance is $120,000, you could, theoretically, be granted a loan in the amount of $40,000. You will, however, be required to qualify in terms of debt to income ratio, credit-worthiness and the repayment term. You would be expected to make regular monthly payments, and default on a second mortgage can have just as serious consequences as non-payment of a primary mortgage. In short, you could lose your home.
Before you put your home on the line, consider the consequences. There is a reason lenders are a little nervous in the wake of the recent housing crisis, and that same financial nervousness should play into your decision regarding a home equity loan. The best advice is to shop around; then carefully weigh the pros and cons.
2 Point Highlight
Home equity loans are not disappearing from the scene, although fixed rate second mortgages may become harder to get as big banks embrace “lines of credit” or HELOCs for the future.
Home equity line of credit loans can be a way for home owners to access cash for improvement projects or debt consolidation, but consumers should carefully weigh their options.
