Photograph by Jean Newton
Raymond Molina, bank manager at California Federal Bank in Los Altos and director of affiliate members for Silicon Valley Association of Realtors, warns that it's important to have your financial house in order to repay loans.
Home equity loans can be a powerful tool
By Jean Newton
It can be quite shocking when the bills arrive in January and the total amount spent during the holiday season is a lot higher than expected. Many homeowners don't realize they have a powerful financial tool available to help pay those expensive bills. By taking out a home equity loan, consumers can consolidate high-interest credit card loans to ultimately save money.
A home equity loan, based on the difference between how much you owe on your mortgage and the current cost of your home on the market, offers several benefits and a few caveats.
"It's a great idea for consumers who need to get their finances in order, want to make home improvements or finance a child's education," said Raymond Molina, bank manager at California Federal Bank in Los Altos and director of affiliate members for Silicon Valley Association of Realtors." It's also a good tax advantage since people have the ability to write off the interest on their loan."
According to the National Home Equity Mortgage Association (NHEMA) home equity loans have become more popular than ever before with more than 4.5 million American families now benefiting from nonprime home equity loans, generally at interest rates only slightly above prime. Nonprime lenders, including some of the country's largest financial institutions, originated $160 billion in loans last year.
Using the investment in your home is a valuable financial asset, but it does carry some risk, advises NHEMA. Borrowing to pay off credit card debt with a home equity loan can help improve your financial picture if you manage your money wisely. However, if finances aren't managed properly and you are not able to repay your loan, you could face financial trouble, including bankruptcy and the loss of your home.
Home Equity Options
Approximately 30 percent of borrowers use home equity loans for debt consolidation, while 25 percent use the loan to purchase a home, 25 percent to take care of medial emergencies or education expenses and 20 percent to make home improvements. There are several ways to tap into the equity in your home, including a second mortgage, refinancing, or a home equity line of credit.
A second mortgage is a loan against the equity in your home where you get a lump sum to pay back in monthly installments, usually for a fixed rate, over a fixed term that is often less than a conventional 30-year first mortgage. When you take out a second mortgage, you will have two active mortgages.
If you choose to refinance your higher interest mortgage loan, you have the option of taking some of your equity out in cash and paying a lower interest rate for the total loan, often saving you hundreds or thousands of dollars a year. Before you consider refinancing, though, it's important to check out closing costs, prepayment penalties and other expenses. The paperwork can also be extensive.
With a home equity line of credit, you only dip into your equity when necessary. The line of credit functions more like a credit card and you often receive a special checkbook. When you write a check, you borrow directly from the equity in your home, usually at lower rates than most credit cards and with the advantage of writing off the interest on your taxes--something you can't do with credit card interest.
A Financial Tool
Molina said he has seen an increase in the demand for home equity loans during the past year at his bank. As a financial tool, he believes the home equity loan provides a viable solution whether consumers need to take care of a stack of bills, remodel their house or get their children through college.
"Many people need to look at debt consolidation when the low introductory rate on a credit card takes a jump up to 23 or 24 percent, in some cases. The home equity loan is a practical way to get a cheaper source of funds," said Molina.
Additionally, Molina said the middle generation is using home equity loans to help finance their children's education since tuition has skyrocketed in recent years. Parents are often in a tax bracket that prevents the child from getting financial aid, yet it's becoming more expensive to meet tuition costs that now are anywhere from $15,000 to $30,000 per year.
Perhaps the most important reason consumers are finding home equity loans attractive is due in part to the untapped wealth of equity in the community. With the value of homes in Silicon Valley at an all-time high, home equity has become a hidden treasure.
"Many people are empty-nesters. Their houses are paid off and they only have property tax and homeowners insurance to worry about," Molina said. "It makes a lot of sense for them to use the equity in their homes to upgrade their property by remodeling or updating or to buy a vacation home or lot."
When considering a remodel or structural changes that aren't just cosmetic in nature, such as wallpaper or paint, Molina advises getting a line of credit before starting any construction work. One thing he hears quite often is 'I wish someone had told me that before I started.'
"It's advisable to apply for your loan first before embarking on any structural changes so that the loan is based on the current appraisal value of your home. If you wait until you are in the middle of construction, it will take much longer to get your loan and it's a much more involved process, often requiring the submittal of the plans," Molina said.
Home Equity Requirements
Molina recommends applying for a home equity loan before you need it. Although there are certain loans that can be approved on the spot, it isn't possible to get a home equity loan overnight. Making sure your application is completed accurately will help speed the process along.
The application process will include an appraisal of your home and an evaluation of your credit history. In addition to asking how you plan to use the loan, lenders will also look at your ability to repay the loan, proof of income, how much of your current earnings go towards paying off debt and the amount of your loan compared to the value of your home.
One of the most important items is finding a reputable lender or broker to help you through the process. Someone with consumer loan expertise and knowledge will make it easier to get your home equity loan. Check with your Realtor for a recommendation or ask family and friends about their experiences. You can also check out the NHEMA website for more information at www.nhema.org.
"While there are many loan options available to consumers, the home equity loan meets a variety of needs," said Molina. "It's important to talk with someone who can evaluate your particular situation to see whether it's the best financial move for you."
Saratoga, California Since 1955
