The leakingroof is not covered by any insurance. The dying car must be replacedbecause you live way out of town. Minimum payments on your high-interest credit cards, now loaded up with years of small end-of-the-month expenses, are busting your budget. Unexpected expenses seem to pop up regularly. Like Murphy’s Law that says, ‘what can go wrong will go wrong,’ these inconvenient demands for money happen when we can least afford them.
Where do we turn? One place we look is to our homes, which we have always seen as a store of value. How do we pull cash from our homes? Where do we go and who do we talk to? How do we know that we are getting a good deal and that what we are doing is safe? Let’s look at home equity loans from a senior’s perspective.
About half of the net worth of most American households is tied up in home equity. (‘Home equity’ is what you own in your home. It is what you have when you subtract the debt you owe on your home from the fair market value of your home.) It makes sense that seniors looking to supplement their finances would turn to their home equity.
Three of the more popular ways to access your home equity include reverse mortgages, home equity lines of credit (or HELOCs) and home equity loans. With a reverse mortgage, you get a sum of money, but do not pay it back until you leave your home, either to live somewhere else or through death. The repayment typically comes from the sale of the house. With a HELOC, the lender establishes a line of credit for you, secured by the equity in your house. You take out money as you need it and pay down the outstanding balance as you can, plus interest, much as you would a credit card. The interest rate is often variable, instead of fixed.
With a home equity loan, or secondary mortgage, you borrow a fixed amount of money, typically 80 percent or less of the equity in your home, for a fixed period of time. The amount offered, which varies with your available income and credit rating, is usually much less than 80 percent. Most large lenders will add the value of the home equity loan you are requesting to the balance of your primary mortgage (if you have one), to see if you still have at least 10-30 percent equity in your house. If not, your request will likely be denied.
Much like a primary mortgage, you will have a fixed interest rate, a loan term and monthly payments. The ownership of your home is not affected as long as you make your payments, and you get to benefit fully from any appreciation in your home’s value. If you qualify, you may even have some benefit when you file your taxes.
Regardless how well we plan, life has a way of throwing us a curve ball. Maybe credit card balances are too high because of medical copayments, car repairs and unexpected house maintenance, and we want to lower the interest rate. Maybe we need to cover long-term care for a spouse. Whatever our reason for needing cash, a home equity loan can be a good solution if we do not put our home at risk in the process.
Some seniors consider selling their home and downsizing to something smaller and less expensive. While that is another way to generate available cash, it may be more disruptive than you are willing to deal with at this time.
Having access to funds through a home equity loan means:
- Being able to meet financial obligations without a major disruption like downsizing;
- Paying a much lower interest rate than what credit cards often charge, by consolidating debt;
- Keeping bill-paying current, so we don’t fall behind and ruin our credit rating;
- Not having to ask our adult children for financial assistance; and
- Having funds available to take care of emergency expenses that crop up.
If we are considering taking out a home equity loan, that usually represents some level of frustration or anxiety because we are dealing with a financial shortfall of some kind. We want to find the least-cost way of solving the problem, and one that is based on ease and not more stress. Besides the cost involved, we want to know how easy it is to put a home equity loan in place, what it would take to cancel if needed and what kind of customer support we can expect.
We also want more information on the loan itself: minimum and maximum loan amounts, repayment periods, contractual obligations and what fees might be involved. Then we want to know about the interest rates: what the annual percentage rate is, if it is variable or fixed and if any discounts are available. Lastly, is a home equity line of credit (HELOC) an option?
Once you have decided to take out a home equity loan, you want to prepare yourself with some basic pieces of information. First you want to find out what your credit score is, since this is what lenders use to define how reliable you are as a borrower. Knowing your score will tell you how much leverage you will have when negotiating with lenders. An ‘excellent’ score increases your leverage; a ‘fair’ or ‘poor’ score decreases it. Also check your credit report for mistakes, as a mistake might lower your credit score and make any loan more costly.
Identify 4-5well-known, reputable companies that offer home equity loans. These could include your bank or your mortgage lender, or savings and loans, credit unions or other regulated financial institutions. Since you are using your home as collateral for the loan, you do not want to find yourself dealing with a less-than-honorable company that would be more likely to slip some harmful detail into the fine print of the contract.
Decide on the net amount you want as a loan. Contact each company directly to discuss your request, asking questions wherever you are unclear. Have the representative define the interest rate, the term and the monthly payment in writing.When done, you want three offers to compare. When comparing those offers, look at the APR, or annual percentage rate, instead of just the interest rate. The APR combines the yearly interest rate with any incidental points and financing charges in one number and makes it easier to compare one loan to another. The lower the APR, the better.
Also, determine if the loan has a fixed or a variable interest rate. A fixed rate means the interest rate will remain the same for the life of the loan. A variable rate is tied to some external index, which means it will be open to rising or falling with the market. Variable rates can be lower at the start of the loan and may seem like an appealing choice. However, your monthly loan payments could increase without warning and make it difficult for you to make them with your budget.
Next, you want to be sure the home equity loan you pick is one that fits in with your ability to pay it back. Check your budget again to be sure you can afford the monthly payments. Whatever you do, avoid being talked into a larger loan than you want or can afford easily. You do not want to put your home at risk because you agreed to payments that are too onerous: missed payments could lead to the lender repossessing your home.
Be particularly careful of offers for other add-on products; examine them and be certain they have real value to you and will not make the loan unaffordable. Also, know that you do not have to turn over the deed to your property to obtain a loan. If you get talked into doing so, you relinquish control over your home.
Two areas differentiate what seniors prioritize from what younger people do when taking out home equity loans: age-friendliness and health-related value.
Age friendliness: Your age should not affect your interaction with a company you have contacted about a home equity loan, as long as you have all the details in hand when you do so. What is different from someone younger is the need for extreme caution because of the time horizon you have: the earlier we are in life, the greater ability we have to overcome a mistake. By our sixties, our income-earning ability is starting to lessen, which makes it harder to generate the additional money needed to reverse a bad decision.
Health-related value: Your health would be far more relevant if you were taking out a reverse mortgage, instead of a home equity loan. With a reverse mortgage, your loan would come due when you left your home, whether to assisted living, to go live with someone or due to death. With a home equity loan, in case of death the loan remains active regardless, with an outstanding balance. If others live in your home, the lender might agree to an arrangement for someone to take over your payments, especially if they inherit the home. If you have credit insurance, it might pay off the loan. Otherwise, the debt becomes part of your estate, either settled with existing assets or with the proceeds from the sale of the home.
When taking out a home equity loan, you will be comparing interest rates and APRs (annual percentage rates). However, you also need to look for any extra percentage points, fees or interest add-ons the lender might be charging and that are not rolled into the APR. Here are some to look for:
Application or loan processing fees: the lender might charge these fees to cover the cost of reviewing and vetting your loan application. Often around $100, these fees might be returned if the lender denies you the loan.
Appraisal fees: lenders want to know the market value of your home, so they can calculate what equity you have in it. The fees cover the cost of professional appraisers; check with the lender if there is a less expensive method to get this information without having to pay an appraiser.
Broker fees: if you have gone through a broker to obtain a home equity loan, you will be responsible for compensating the broker for services, whether as a flat fee or a percentage of the loan the broker obtains for you. This fee can be avoided if you work directly with potential lenders, which just requires a little more legwork.
Document preparation and recording fees: if your lender uses attorneys or financial specialists to complete paperwork on your loan, they may charge you additional fees. Ask up front what ‘doc prep’ fees might be involved and include that cost in your comparison of two or three potential lenders’ quotes.
Hidden fees: Hidden loan terms may show up in the fine print of your home equity loan contract. Be sure to read it carefully, especially if you see anything about discounts on payments that result in a balloon payment or lump-sum final payment at the end of the contract.
Interest payments: these are the largest fees charged for access to money through a home equity loan: the actual cost of the money. While interest rates on home equity loans are favorable compared to those charged for credit cards, for example, the rate is still an important decision-making factor as it affects the total cost of the loan over time.
Origination or underwriting fees: the lender might charge up to a few percentage points to open an account for you. Usually between zero and two percent, it needs to be taken into consideration when comparing home equity loans as it has a material impact on the total cost of the loan.
By the time you are a senior, you would prefer for any financial transactions to be painless and simple to complete. Taking out a home equity loan is no different, especially because you may be taking it out to resolve an already-stressful problem: to cover unexpected expenditures or accumulated debt.
Cost: Comparing the cost of a home equity loan goes beyond just the interest rate. You need to look at all additional costs and fees. The ideal situation would be to compare identical loan proposals from two or three potential lenders, that is, the same net amount of cash paid out, repaid over the same time period. That way, your monthly payment will clearly show the best option: the lower, the better.
Ease: Once you have identified a few reputable potential lenders and are clear about what you are seeking in the form of a home equity loan, you should expect easy access to information online and through the company’s representatives, all without sales pressure. Whatever company manages to makes the introductory, application-processing, funding and repayment phases smooth and transparent will have earned your business.
Cancellation: A home equity loan is a contractual obligation. However, under a federal law called the Truth in Lending Act, you should have until midnight the third business day after a contract was signed to cancel, whenever you pledge your home as security (except on primary mortgages). The lender must advise you of your right to cancel and must give you a cancellation form when you sign your loan papers.
Once that period has expired, the only way to ‘cancel’ a loan would be to pay it back in full. The payback amount may be larger than the original loan payout because of accrued fees, such as application, document preparation, brokers and other fees. There may also be an early repayment (or prepayment) penalty. These details should be identified in the fine print before signing a contractual agreement and avoided whenever possible.
Customer support: Both before and after you take out a home equity loan, you would expect the lender’s customer support team to answer any questions you might have. Representatives should be available during normal business hours by various means: online, by email and by telephone.
Today many lenders are looking to make loans against the solid equity in homes, as long as the fundamentals (income, credit scores and equity) support them. Whether you go directly to lenders or through ‘facilitators,’ you want to compare how much money you will get and how much it costs you. It is important to understand the different elements well enough to demand that the loan be clean of hidden and unnecessary fees.
Feel free to negotiate with various lenders, letting them know they are competing with other lenders for your business. Before you sign for a loan, take the time to read the loan closing papers carefully. Do not hesitate to question anything that looks like it might have been changed or added.
Because the home equity loan business is rife with scams that target seniors, at times leaving victims without a home, the Federal Trade Commission (FTC) is particularly vigilant, and offers excellent information on its website under ‘Home Equity Loans and Credit Lines.’ If you encounter anything that feels uncomfortable, do not hesitate to contact your state’s attorney general’s office or the FTC immediately.
One word of warning: During the housing bubble, it was very common for people to use the equity in their homes as a form of piggy bank. However, the financial crisis of 2008 taught us that housing prices do not only go up; they also go down. Depending on their contracts, some people lost their homes when housing market prices fell because the equity in their homes disappeared. With negative equity, the lender may demand immediate payment of the loan.