November 2, 2006  
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Featured Issue: Make the Most of Your Home Equity

Avoiding the Pitfalls of Home Equity Loans

In order to steer clear of the types of mistakes frequently associated with home equity loans, you need to know where to look for them.

Here's where the hazards are most likely to occur:

Your Reasons for Wanting the Loan

  • Be sure you've used good judgment in making your decision to use your home equity in this way.
  • This type of loan is a legitimate way to consolidate other high-rate debt to get a lower interest rate.
  • Up to a certain point and under specific circumstances, your interest on a home equity loan is tax deductible. Talk with your tax advisor before jumping in blindly.
  • Explore home improvements that will increase the value of your home or qualify as capital improvements, because these are assets whose benefits will have long-term value.
  • Spending loan funds for educational purposes would be considered a better choice than using the money to buy a car. Why? Because cars depreciate in value. Investing in college or on-going training for your children or yourself, is an valuable asset that will help ensure your financial future.
  • It's inadvisable to use home equity loans for living expenses. The last thing you want to do if you're having problems making ends meet, is put your hard-earned home equity at risk.

When you and your tax advisor are confident that a home equity loan of some type would be beneficial to your financial well-being, you'll be faced with a different set of pitfalls.

Comparison Shopping and Negotiating a Good Deal

  • Be prepared. It will take some time to shop around and compare rates. One of the biggest pitfalls when looking for a home equity loan is making your move too soon, or imagining that lenders are all pretty much alike. They're not.
  • Be sure that the loan offers you compare are identical in every way but price. One mistake some homeowners make is to not read the fine print, or to compare a second mortgage type loan with a line of credit offer. Don't compare apples to oranges, as the old saying goes.
  • When you have multiple written offers in hand for the same loan product, prepare to begin negotiating for the best deal.
  • Borrowers with identical financial profiles and credit ratings can receive very different loan deals. How can that be? It's all in how well you negotiate.

Use Good Negotiation Strategies

  • Let the lenders you've approached know that you're looking at multiple loan offers. It's a very competitive industry, which will work in your favor if you work methodically.
  • Ask each lender to sweeten the deal in one or more of these ways: lower the interest rate; reduce points; or waive or reduce one or more of its fees.
  • Before making your final decision, double check that when a lender agreed to lower one fee, they didn't actually raise another one, burying the added-back cost somewhere in the offer. It happens.
  • Looking at offers from at least three separate lenders will also help you to more easily spot an offer that's remarkably different, which may be a warning sign of unscrupulous lending behavior.

Home Equity Fraud

Fraud is an ugly word and being cheated by a lender seems unlikely to most homeowners. But home equity fraud is rampant. In a worst case scenario you could actually lose your home to an unscrupulous or abusive lender whose real objective is to set you up for a scam to force you into foreclosure. Take these precautions when shopping for a home equity loan:

  • Get a written statement of all settlement costs in advance.
  • Inspect settlement documents closely for something called "affiliated business" connections among appraisers, realty agents, mortgage brokers or title companies.
  • Ask questions about any fees charged by a company you don't recognize.
  • For more information on home equity loan fraud and resources if you think you may be a victim see Additional Resources.

The benefits of learning to manage your home equity can be significant. For more information go to Additional Resources.

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