Planning Ahead for a Home Equity Loan

By Tom Kerr

Home equity loan delinquencies are on the rise, as many consumers fall behind on their payments. But you can help to avoid those problems by planning ahead before you borrow, or by using a flexible home equity line of credit or HELOC.

The American Banker's Association now reports that delinquencies for home equity loans are trending steadily upward, pushed by the higher cost of adjustable interest rates. Interest on most mortgages and home equity loans is tied to the prime rate, and it rose dramatically within the past two to three years as the Federal Reserve hiked rates 17 times. During the same timeframe, many houses also lost market value because the real estate market slumped, making it harder to sell them to pay off mortgages. Homeowners who default soon lose their homes to foreclosure.

Look before you leap

To avoid becoming one of these unfortunate statistics, experts recommend that you carefully plan your financial future before applying for any kind of home equity loan. Because these loans are secured by your home, missed payments can result not just in penalties and fees, but also in the tragic loss of your house.

The easiest way to borrow against the value of your home is through a home equity loan or home equity line of credit (HELOC). Regardless of which method you choose, it's recommended that you don't borrow more than you absolutely need. Also, beware of offers to loan you more than 100 percent of the value of your home. Those loans could leave you "upside down" or owing more to the lender than your house is worth. While you struggle to make payments, your indebtedness will grow because of accrued interest, and the snowball effect can soon get out of control.

Boost your home's value

Some financial counselors advise that you use home equity loans only to make direct investments in your home, such as room additions or remodeling projects. That way, the loan helps boost your home's value. Using equity loans to pay for nights out on the town, a new wardrobe, or other temporary treats you otherwise couldn't afford can be a quick path to red ink. In the end, you might put your most important asset-your home-in jeopardy.

HELOC help

Those wishing to borrow money for special projects or expenses may prefer to use a HELOC instead of a home equity loan. The lender will determine your credit line based on the value of your property, your income, and your routine expenses. Then you'll be given special checks or a card similar to an ATM card. You can access your credit line with cash withdrawals until you reach your limit; at that point, you'll be denied access until you pay off some of the balance. This provides a built-in mechanism to protect you from overextending yourself. All of us can benefit from that kind of budgetary guidance or imposed discipline from time to time.