Beware of No-Equity Home Loans

Using a portion of one’s home equity is one thing; exceeding your equity completely is quite a different matter. A large number of people have fallen victim to the lure of the no-equity home loan.

No-Equity Home Loan = High LTV Home Equity Loan

A no-equity home loan is simply a more attractive name for a high loan-to-value (LTV) home equity loan, in which the loan amount of the mortgage actually equals or even exceeds the value of the property, sometimes by as much as 25 percent. This actually creates a combination secured/unsecured loan. Not surprisingly, these very risky and expensive loans are aimed at those who desperately need a quick cash infusion. And, unfortunately, that's a booming market. Indeed, loan originations in the subprime market have grown from $25 billion in 1993 to over $180 billion today.

Problems of Using No-Equity Home Loans

There are many problems with these loans. To begin with, the interest rates are extremely high. They’re generally two- to six percentage points higher than traditional home equity rates. Then there are the fees, which are also higher than those for standard home equity loans. Of course, the total cost of the loan can vary greatly, depending upon your credit rating, the lender, market interest rates, and the structure of the loan. You’ll also be required to purchase Private Mortgage Insurance (PMI), which typically adds an additional one-half to one percent onto your loan balance. You’d need the PMI to cover the amount of the loan that’s greater than 80% of your home's value, but doesn't yet exceed 100%. In other words, you'll need PMI on 20% of the secured part of your loan.

Tax Implications of a 125% Home Loan

You’ll also have to consider the tax implications of a 125% home loan. Home equity loan interest is tax deductible up to a maximum of $100,000 ($50,000 if you're married filing separately). But those rules are slightly different with high LTV loans. Any interest paid on the amount of the loan which exceeds your home's value is not tax deductible. So be sure to consult your tax adviser before committing to any of these loans.

Selling your home may also pose a problem. If you needed to quickly sell your $100,000 home that you owe $125,000 on, it’s pretty likely that you’ll have quite a dilemma. If you couldn’t come up with the full amount that you owed when you sold the home, your loan would be in default. And at that point you're probably looking at foreclosure and possibly even bankruptcy.

Don't get caught by the slick advertising for these loans. If you need to borrow more than the equity that you have in your home, it would probably be more advantageous for you to combine a traditional home equity loan with an unsecured personal loan rather exposing your dwelling place to such a high risk.

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