Dirty Secrets of Home Equity Loans

The credit marketplace appears to be highly competitive for consumers who are thinking about buying a home or refinancing an existing home loan. Mortgage loan rates can often be found in most newspapers and on the Internet, making it easier to comparison shop. In a typical home equity loan, you borrow cash against the equity in your home and repay it over a fixed term. You pay most of your fees and closing costs up-front and choose a fixed or variable interest rate. Sounds simple, right?

It usually is. But some home equity loans harbor dirty little secrets. They trap consumers into paying more than they should and can even force them to foreclose on their homes if they get in over their heads. Remember: All home equity loans put your house on the line since your property is used as collateral. And that's the last thing you want to lose. The Better Business Bureau urges consumers to always check out a company BEFORE doing business with them. Visit our website at www.buffalo.bbb.org for free reliability reports.

Before you sign on the dotted line, make sure you know about these pitfalls:

• Excessive Mortgage Broker Compensation. In the sub-prime market, there are mortgage brokers who will attempt to sell the borrower on a loan with the most fees and highest interest rate possible so that he/she will get more compensation. Some of these brokers may charge fees of 8 to 10 points. That means that on a $100,000 loan, the borrower is paying and financing an additional $8,000 to $10,000.
• Excessive Points and Fees. Most borrowers can expect to pay a 1% origination fee and possibly another 1% of the loan amount in points, as well as basic closing costs, which would include appraisal and attorney's fees. Some predatory lenders load up loans with these up-front charges and charge additional "junk fees" to pad the closing costs.
• Sell the Monthly Payment. Many brokers and lenders advertise "bill consolidation" home equity loans. Predatory lenders encourage consumers to pay off all their debts by consolidating them into one home loan with the promise to reduce the monthly debt payment. The problem with this is that the consumer is trading short-term debt for long-term debt. Instead of paying off consumer credit bills in three to four years, the new consolidation loan will take 15 to 30 years to pay off. To avoid becoming a victim, consumers must look beyond the monthly payment and analyze all the terms of the loan.
• Balloon Payments. Another way for a predatory lender to reduce the monthly payment on a home loan is to have the borrower pay off only the accrued interest each month. This method of financing will result in a huge balloon payment at the end of the repayment term, usually after 15 years. If the borrower is elderly, it will be very difficult to refinance the loan, and foreclosure may become inevitable.
• Equity Stripping. An unscrupulous lender targets consumers with a significant amount of equity in their home and offers to lend an amount that is more than the borrower can financially handle. The borrower defaults and the lender then forecloses and sells the house, stripping the homeowner of all the equity he has earned over the years.
• A few extras. Make sure you recognize every document placed in front of you. If the lender asks you to sign papers that include monthly charges for insurance premiums or other 'services' that weren't mentioned before, that's questionable. The FTC calls it 'credit insurance packing'. If you refuse to sign an 'extra' document, and the lender objects or says your loan papers will have to be rewritten or reconsidered, walk away.
• Flipping. This occurs when predatory lenders encourage consumers to repeatedly refinance their loan. Each time the loan is refinanced the lender charges more fees, placing the borrower further in debt over a longer period of time
• Prepayment penalties. Paying debt early should be a good thing. Watch out for loans that charge steep penalties for 'overpaying' each month and wiping out your debts before your term is up.. A predatory penalty might be 10 percent of the amount borrowed or a sum equal to three months' worth of payments.

The one saving grace is the Three-Day Cooling-Off Rule. If you're borrowing against the equity in your primary residence, you have the right to walk away from that home equity loan if you change your mind for any reason within three days of its issue, according to the Truth in Lending Act.

You must inform the lender of your wish to cancel the loan in writing and within three days of issue. The lender must then cancel its security interest in your home and return all fees to you, including any application and appraisal fees you paid to open the account.

This information is general in nature and is not intended as a reliability report on any company, product, or service.