Dangers Presented by Home Equity and Debt Consolidation Loans
Home Equity Loans
The major drawback of all second mortgages, home improvement loans, and home equity loans is that the creditor requires the borrower to put their house up as collateral for the loan.
Once you as the borrower give a creditor a lien on your real property, then you have given the creditor the ability to foreclose on your property if you are unable to make the monthly payment. This is true even if you are current with your first mortgage.
Home equity loans are often sold by brokers to and ultimately used as a “solution” by people who don’t have enough income to repay their unsecured debts. This all too often results in long-term payments that are beyond their means. This sad fact is all the more tragic when you consider that each state has laws that protect a certain amount of home equity from creditors. Additionally, the federal bankruptcy laws allow you to discharge your unsecured debts and keep the protected equity in your home. Unfortunately, when people opt to pay off all of their unsecured debt through a home equity loan, rather than filing a bankruptcy, they turn dischargeable debt into secured debt. Thus, if they end up having to file a bankruptcy later on, they get stuck with a lot of debt that would have been discharged if they hadn’t taken out the home equity loan.
While home equity loans may be attractive because they usually offer low interest rates and lower monthly payments, the total amount of payments often adds up to much more than the amount of the original debt that was consolidated. The total amount of interest that you pay over such a long period of time, usually 15 to 30 years, can be huge. Home equity loans can quickly turn disastrous for many people, given the frequently changing economy and unstable job market. Banks offer these low rates because they know that they can foreclose on the property if you fail to pay back the loan. Furthermore, when interest rates are low, borrowers are especially vulnerable to getting in trouble with home equity loans. Most home equity loans are variable rate loans, and the interest rate charged by the bank increases as the Federal Reserve Board increases the prime rate. As interest rates increase, a once affordable home equity loan payment may dramatically increase, making the home equity loan payment unaffordable.
Borrowers often need to be wary of hidden lender costs that quickly run up the cost of the loan. Borrowers are usually responsible for paying for title insurance, a new appraisal, origination fees, commitment fees, and possibly brokers’ fees. Other disadvantages of home equity loans include “balloon payments” and “teaser rates.” A “balloon payment” requires the borrower to pay off the entire loan within a certain number of years. This usually results in having to take out an additional loan and accordingly incurring more fees and costs. Borrowers without great credit might not be able to obtain a loan large enough to pay off the existing home equity loan and thus, will quickly find themselves facing foreclosure. A “teaser rate” is a low introductory interest rate that can increase during the term of the loan, sometimes by several percent, drastically increasing the total cost of the loan. Some home equity loans can be “flipped” into a new loan with a higher interest rate and add other additional costs.
Many people who take out home equity loans ultimately discover that they end up owing more money on their houses than they are worth. Obviously, this is extremely risky, and although the real estate market traditionally appreciates over time, it is dangerous to rely on real estate appreciation to ultimately meet the total amount owed on your home. Many people find themselves in situations where even selling their home would not generate enough money to pay off the home equity loan, after having to pay off the first mortgage and account for closing costs.
Debt Consolidation Loans
Debt consolidation loans are personal loans that allow people to consolidate their debt into one monthly payment. The payment is often lower than the total payments of their current loans because this loan is spread out over a longer period of time. Although the monthly payment is lower, the actual cost of the loan is dramatically increased when the additional costs over the term of the loan are factored in. The interest rates on personal debt consolidation loans are usually very high, especially for people with financial problems. Lenders frequently target people in vulnerable situations with troubled credit by offering what appears to be an easy solution.
Debt consolidation loans can be either secured or unsecured. Unsecured loans are made based on a promise to pay, while secured loans require collateral. Upon default of the loan payment in a secured loan, the creditor has a right to repossess any of the items listed as collateral for the loan. Many lenders require the borrower to list household goods as collateral in order to obtain the loan. Upon default, the lender may repossess any of the items on the list. The federal bankruptcy laws allow you, in many cases, to remove the lien on the household goods listed as collateral and eliminate the debt.