Equity loans: More popular, but more confusing
By Holden Lewis
Many homeowners don't understand what an equity loan is. Lenders worry that consumers believe equity loans have high closing costs and are a hassle to apply for. And bankers think that a lot of potential borrowers don't know the differences between home equity loans and equity lines of credit.
These issues are coming up because mortgage rates have risen about 1 percentage point in the last year. With that rise in rates came the end of the long refinancing boom: In 2003, two out of three mortgage applications were from homeowners who were refinancing their loans, according to the Mortgage Bankers Association; in the second week of June 2004, the refinance share was 34 percent.
Last year, almost half of refinancing borrowers did "cash-out refis" -- they refinanced for more than they owed and pocketed the difference. Now that rates are higher, homeowners don't want to refinance again. "The only way to cash out is to take out a home equity loan or line," says Anthony Hsieh, president of HomeLoanCenter.
Lenders are chasing after equity borrowers by offering airline miles and gift cards at stores such as Costco, as well as by touting the ease and low costs of applying for the loans.
Home equity baffles
When you get a home equity loan, you are borrowing against your ownership stake in the house. The equity is the value of the house minus your mortgage balance. A home equity loan uses your equity as collateral. If your house is worth $200,000, and you owe $140,000 on the mortgage, you have $60,000 in equity. A home equity loan would allow you to borrow some or all of that $60,000.
Who needs a line, who needs a loan
A line of credit starts with a draw period and ends with a repayment period. During the draw period, the homeowner can borrow against the credit line by using a charge card or a checkbook. Minimum monthly payments cover only the interest during the draw period. When the repayment period starts, the monthly payments cover interest and principal so that the balance is repaid by the time the credit line expires. The length of the draw and repayment periods varies with the lender and size of the credit line.
Generally speaking, interest is tax-deductible on the first $100,000 of debt with both types of loans.
Lenders are looking for equity customers to replace their vanishing refinancing borrowers. In addition to dangling incentives such as airline miles, they are touting the low expense of applying for equity debt. A few years ago, homeowners had to pay closing costs -- usually between $150 and $800 -- for equity loans or lines of credit.
But now many equity lines of credit come with no fees, especially if the borrower makes an initial draw (akin to a credit card charge) when the account is opened. Sometimes you have to make an initial draw of thousands of dollars to get the fees waived. With equity loans, aggressive lenders either charge no fees or a few hundred dollars' worth.
"Most companies, such as us, give them away," says Hsieh of HomeLoanCenter. And with inducements such as air miles, "nothing gets a customer more excited than somehow dreaming of a free vacation to Hawaii," he adds.
Banks are looking for ways to encourage customers to use their equity lines of credit instead of letting them sit idle for a rainy day. With its Home Asset Management Account, Wells Fargo increases a customer's credit limit as the home's value increases. With its fixed-rate option, Bank of America lets customers convert all or part of the balances on equity lines of credit into fixed-rate loans -- in essence, combining equity loans and equity lines of credit into one product.