Home Equity Borrowing Still a Pretty Good Deal
Not long ago, homes worked like giant credit cards. Home Equity Lines of Credit (HELOCs) helped borrowers cash in on the equity in the homes.
Dan Wolfrum of Peoria, Ariz., bought his home at a foreclosure auction in 1991 for $51,000. At the time, the four-bedroom, two bath house on a peaceful cul-de-sac in the Phoenix area seemed like a no-brainer.
As the value of his home skyrocketed in the decade that followed, Wolfrum observed fellow homeowners in his neighborhood take out home equity loans to finance swimming pools, SUVs and summer vacations. In the late 1990s, after divorcing and remarrying, the meat distributor salesman finally took the plunge and applied for his own home equity loan to pay for home renovations and a new car. A few more refinances and one loan consolidation later, Wolfrum owes $170,000 on his mortgage.
With foreclosures and short sales rampant in the Phoenix area, Wolfrum's house is now worth less than what he owes. His income in decline and retirement getting nearer, Wolfrum is now working with mortgage experts to lower his payments.
Wolfrum's now-familiar tale might lead one to conclude that home equity loans and home equity lines of credit (HELOCs) are at the top of the current list of homeowner no-nos. But that conclusion would be dead wrong.
Certainly banks have tightened their lending standards, due to declining housing markets nationwide. According to Equifax, the volume of new HELOCs created in November 2009 was $4.9 billion, less than a quarter of the amount created two years earlier, in November 2007. But rates remain at historic lows, around 5 percent for revolving credit HELOCs and just under 9 percent for fixed-rate home equity loans, according to Bankrate.com. Good luck finding credit cards with rates below those.
If you plan to brave the waters of home equity borrowing, here are a few current guidelines:
1. The first key to success is to use home equity borrowing in a sensible, educated way. A good general rule is to reserve it only for something that could be considered an investment, such as education or home improvements. Avoid quickly depreciating purchases such as cars, vacations, and big-screen TVs.
2. Do some serious comparison shopping before signing up with any particular bank or lending institution. These days, many major lenders aren't doing home equity deals, even with consumers with good credit. But some smaller, regional and online banks are. The trick is to find them and find the ones with the best rates. Ask around at local banks and do some searching on the Internet, as well. As always, an excellent credit score helps--over 740 is best.
3. Don't use your house as a piggy bank. A good example of this is not using home equity to pay down credit card debt. This is an easy way to fall into deeper debt without addressing the underlying problem--mainly, that you're spending too much to begin with. Even home improvements and tuition payments can drain your home dry if the spending limits aren't kept in check.
4. Finally, be careful to limit the size of your home equity loan. Avoid combined mortgage and home equity borrowing that leaves a cushion of less than 20 percent equity. If you owe more than 80 percent, you'll pay higher interest rates and eliminate a vital source of emergency funds. Besides, if housing prices continue to decline, you could find yourself "underwater," just like Dan Wolfrum.
Another issue to be watchful of is the increased difficulty homeowners with second mortgages are having in modifying their loans, though President Obama's recent bailout initiative regarding five states that have seen housing values drop more than 20 percent, may easy some of that pain.