Before you sign on the dotted line, make sure you know about these six dirty secrets.
The balloon payment Beware the home equity loan that tempts you with
unrealistically low payments. Look carefully at the terms: payments might be that
low because borrowers pay only interest each month.
That means you must pay
the entire principal -- the amount you borrowed -- at the end of the loan term
in one very large lump sum called a balloon payment, according to the Federal
Trade Commission (FTC). Ouch.
Negative amortization If you think that's
bad, it could be worse. Sometimes, your monthly payments on a home equity loan
don't even cover all of the interest you owe, said Margot Saunders, a lawyer at
the National Consumer Law Center. That means interest continues to accrue and
the total amount owed rises – even though you're not borrowing any more money.
For example, $20,000 borrowed at 10 percent over five years would require monthly
payments of $425 to wipe the balance sheet clean by the end of the term. But say
your loan amortizes negatively (meaning you're not covering the full tab), and
your monthly payments are $150 apiece. At the end of five years, instead of owing
nothing, you've paid $9,000 back, but you owe $21,000. That's because you still
owe the principal plus additional interest that has accrued over the term of your
loan. Saunders said this type of predatory lending occurs less frequently with
home equity loans today than it did five years ago.
Thanks, but no thanks
When it comes time to put your John Hancock on a home equity loan, 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.
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, said Saunders. A predatory penalty might be
10 percent of the amount borrowed or a sum equal to three months' worth of payments.
"Sometimes, consumers aren't allowed to prepay, and that's not fair," said Saunders.
"You should always be able to get out of a high-interest loan early."
"Home
improvement" loans Dishonest lenders sometimes issue unwitting consumers home
equity loans with high rates and fees to finance repairs and home improvements,
according to the FTC. In such scams, a contractor (who works in cahoots with the
lender) arranges for work to be done and tells the consumer he knows of a cheap
way to finance the project.
"The typical pitch they give you is for good,
low-cost financing," Saunders said. But the consumer isn't given documents to
sign until after the work begins. Only then does he realize he is being issued
a home equity loan, and probably an expensive one. But if he tries to negotiate
terms or back out, the contractor threatens to leave the work undone.
You
have three days Okay, it's not exactly a dirty secret – it's a legal right.
But it's crucial information for anyone who wishes to borrow against their home
equity. 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. .
