Home equity loans: abusive lending and how to avoid it
Home Equity loans were initially designed to allow individuals who had not
yet paid off the full amount of their home, the ability to borrow against what
portion of the home they had paid for. So for example, a couple who had been
making monthly payments for many years on their 30 year lease, could use the
money they had already put into their home as collateral when they needed a loan
to send their child to college. So, while the initial intent of the loan is
regarded by some as noble, in practice it has served as a free-for-all for
unscrupulous lenders and other scam artists.
Explaining Sub-Prime Lending
Home Equity Loans fall into a broad category known as sub-prime lending. Unlike
prime lending, which is heavily regulated and offered to those living in good
neighborhoods with fair to good credit, sub-prime lenders target those in bad
neighborhoods with worse credit ratings. Because they offer loans to individuals
who otherwise might have difficulty finding a loan, they were and are able to
justify to the government the need to have greater free reign when it comes to
setting the interest rates and finance charges associated with their loans.
This window, combined with the deep pockets of Home Equity Loan firms able to
grease the campaigns of politicians, has prevented the industry from coming
under the heavy scrutiny and regulation of prime lending. Consequently, what is
seen in this industry is widely varying interest rates, and charges that are
completely disproportionate with the risk incurred by the lending institution.
How to Protect Yourself
For the investor interested in taking on a Home Equity Loan, there are a few
measures which can be taken to radically diminish the chances of being taken
advantage of. The first precautionary step is to request a copy of the loan a
full week before you sign it. The lending institution is required by law, to
provide you with a copy of the loan many days in advance of you signing it. It
is a rather simple task to ask for the loan, and the lending institutions
response often reveals much about the quality and legality of the loan. If the
lending institution says, that either the loan paperwork is not yet ready, or
otherwise fails to produce the paperwork inside of a week prior to the signing,
you should walk on the loan.
The catch-22, and consequently the reason why Home Equity Lenders are able to
take such advantage of borrowers, is that often they are facing foreclosure and
desperately need the loan. While your need may be very real, signing a
sub-standard loan will ultimately put you in far worse shape than you ever were
before.
Recognizing the Hidden Charges
The second, and potentially most important technique to prevent predatory
lending, is to demand that all loan costs not be rolled into the APR, but be
listed and paid by you up front. What predatory lenders do to entice individuals
into taking a loan, is to soak up the equity in a home and offer you a small
kickback on the side. So, taking the example of our couple above, let us imagine
that they have $50,000 in equity in their $100,000 home and have a fixed
mortgage rate of $650 a month. They then go to a Home Equity Lender who tells
them that upon signing the loan they will get $20,000 in cash and their new
interest rate will be $580 per month. What they do not tell the borrower is that
they have also cashed out the other $30,000 dollars in equity and paid it to
themselves in "refinancing fees." In addition, the new mortgage they receive may
either be variable, meaning that as interest rates climb so will their new
payment, or be back loaded, meaning that by the end of the loan the payments may
reach $1,200 a month.
Can Home Equity Loans be useful? Yes, but only under ideal circumstances. By and
large, they are a product designed by unethical lending companies to take
advantage of those desperate for a little cash now. If you plan on applying for
a Home Equity Loan, it is vital that you take the two steps outlined above as
well as have an experienced independent third party go over the loan and its
convoluted terms with you.