Using Your Home as Collateral

Home Loan Articles >> Using Your Home as Collateral

If you need money to pay bills or make home improvements, and think the answer is in refinancing, a second mortgage, or a home equity loan, consider your options carefully. If you can’t make the required payments, you could lose your home as well as the equity you’ve built up. That’s why it’s important not to let anyone talk you into using your home to borrow money you may not be able to afford to pay back.

Not all loans and lenders are created equal. Some unscrupulous lenders target older or low-income homeowners and those with sub prime credit problems. These lenders may offer loans based on the equity in your home, not on your ability to repay the loan. High interest rates and credit costs can make it very expensive to borrow money, even if you use your home as collateral.

Talk to an attorney, financial advisor, or someone else you trust before you make any decisions about borrowing money. Non-profit credit and housing counseling services also can be useful in helping you manage your credit and make smart decisions about financial decisions.

Avoid Any Lender Who:

tells you to falsify any information on the loan application. For example, if you are asked to state that your income is higher than it is.

pressures you into applying for a loan or applying for more money than you need.

pressures you into accepting monthly payments that you can't make or could have trouble making.

fails to provide required loan disclosures or tells you not to read them.

misrepresents the kind of credit you're getting, like calling a one-time loan a line of credit.

promises one set of terms when you apply, and gives you another set of terms when you sign, with no legitimate explanation for the changes.

tells you to sign blank forms, and says they will fill in the blanks later.

says you can't have copies of any documents that you have signed.

There are several steps you can take to protect your home and the equity you've built up in it.

Shop Around--Costs Can Vary Greatly

Contact several lenders including banks, savings & loans, credit unions, and mortgage companies. Ask each lender about the following items:

The annual percentage rate (APR). The APR is the single most important thing to compare when you shop for a loan. It takes into account not only the interest rate, but also points (one point equals 1% of the loan amount), mortgage broker fees, and certain other credit charges that the lender requires the borrower to pay, expressed as a yearly rate. Generally, the lower the APR, the lower the cost of your loan. Ask if the APR is fixed or adjustable (will it change, and if so, how often and how much?)

Points and fees. Ask about points and other fees that you'll be charged. These charges may not be refundable if you refinance or pay off the loan early. And if you refinance your home, you may pay more points. Points are usually paid in cash at closing, but may be financed. If you finance the points, you'll have to pay additional interest, increasing the total cost of your loan.

The term of the loan. How many years will you make payments on your loan? If you're getting a home equity loan or a debt consolidation loan, remember that the new loan may require you to make payments for a longer time.

The monthly payment. What is the amount? Will it stay the same or change after a certain number of months? Find out if your monthly payment will include escrows for taxes and insurance.

Balloon payments. This is a large payment usually at the end of the loan term, often after a series of lower monthly payments. When the baloon mortgage payment is due, you must come up with the money. If you can't, you may need another loan, which means new closing costs, as well as points and fees.

Prepayment penalties. Prepayment penalties are extra fees that may be due if you pay off the loan early by refinancing or selling your home. These fees may force you to keep a high-rate loan by making it too expensive to get out of the loan. If your loan includes a prepayment penalty, understand the penalty that you would have to pay. Ask the lender if you can get a loan without a prepayment penalty, and what the loan would cost. Then decide what is right for you.

Whether the interest rate for the loan will increase if you default. An increased interest rate provision says that if you miss a payment or pay late, you may have to pay a higher interest rate for the rest of the loan term. Try to negotiate this provision out of your loan terms.

Whether the loan includes a charge for any type of voluntary credit insurance, like credit life, disability, or unemployment insurance. Will the insurance premiums be financed as part of the loan? If so, you'll pay additional interest and points, further increasing the total cost of the loan. How much lower would your monthly loan payment be without the credit insurance? Will the insurance cover the length of your loan and the full loan amount? Before you decide to buy voluntary credit insurance from a lender, think about whether you really need the insurance, and check with other insurance providers about their rates. You'll also want to ask each lender to provide, as soon as possible, a written good-faith estimate that lists all charges and fees you must pay at closing. Ask for a Truth in Lending disclosure too. It states the monthly payments, the APR, and other loan terms.

After You Choose a Lender:

Negotiate. It never hurts to ask if the lender will lower the APR, take out a charge you don't want to pay, or remove a loan term that you don't like.

Ask the lender for a blank copy of the form(s) you will need to sign at closing. While they don't have to give you the blank forms, most legitimate lenders will. Take the forms home and review them with someone you trust. Ask the lender about the items you don't understand.

Be sure you can afford the loan. Figure out whether your monthly income is enough to pay your other monthly bills and expenses, as well as the new loan payment.

If you are refinancing a first mortgage, ask about escrow services. Ask if the loan's monthly payment includes an escrow for the property taxes and homeowner's insurance. If not, be sure to budget for those amounts as well.

Before you sign anything, ask for an explanation of any dollar amount, term, or condition that you don't understand.

Ask if the loan terms you were promised before closing have changed. Don't sign a loan agreement if the terms differ from what you understood them to be. For example, a lender should not promise a specific APR and then without good reason, increase it at closing. If the terms are different, negotiate for what you were promised. If you can't get it, be prepared to walk away and take your business elsewhere.

Before leaving, make sure you get a copy of any documents you signed. They contain important information about your rights and obligations.

Don't initial or sign anything that says you're buying voluntary credit insurance unless you really want to buy it.

After the Closing

Having second thoughts about the loan? The Truth in Lending Act gives most home equity borrowers at least three business days after closing to cancel the deal. This is known as your right of “rescission.” In some situations (ask your attorney), you may have up to three years to cancel. To rescind, you must notify the creditor in writing. Make sure you document your rescission. Send your letter by certified mail, and request a return receipt. That will allow you to document what the creditor received and when. Keep copies of your correspondence and any enclosures. After you declined, the lender has 20 days to return the money or property you paid to anyone as part of the credit transaction and release any security interest in your home. Remember that you must then offer to return the creditor’s money or property, which may mean getting a new home loan from another mortgage lender.

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