Dangers of No Equity Loans

Home equity loans have been around for quite a while and for some they have proven to be a useful money management tool. For instance, when the loan is used for remodeling projects and upgrades that increase the value of the home it can make financial sense. "Equity" means the net value of your house after deducting the balance due on your mortgage. For example, if your house would sell for $100,000 but you still owe $60,000 on the mortgage, your equity is $40,000.

Many homeowners have taken advantage of historically low interest rates in the past couple of years by taking out home equity loans to pay off credit card balances or fund large non-household expenses such as new cars or vacations. Some homeowners have opted for no-equity loans, a type of loan that allows a homeowner to borrow more than their house is worth.

Homeowners with impeccably clean credit can qualify for as much as 125 percent of the home's value. For example, if you purchased a home for $100,000 and put $10,000 down. You would have $10,000 of equity in your home. With a traditional home equity loan you could receive up to $10,000. On the other hand, with a no-equity loan you could qualify for up to a $35,000 loan.

Many consumers take no-equity loan options at face value and neglect to ask "what's the catch"? First of all, unlike a home equity loan which usually comes at an attractive interest rate, a no-equity loan's interest rate can be several percentage points higher. While clearly more expensive than a traditional equity loan, no-equity loans are still cheaper than most credit card interest rates. Hence the popularity of no-equity loans for bill consolidation. Secondly, there's a high price for convenient cash. In both instances, closing costs and application fees do apply and can run as high as $2,000.

The most frightening part of no-equity loans is the simple truth that you have borrowed more money than your house is worth. What would you do if you were forced to sell your home? You would still owe a good chunk of money after paying off your mortgage. Furthermore, the lien holders may not allow the sale to proceed unless they are paid in full as part of the sale. Will you have a few extra thousand dollars available to clear the debt?

Before proceeding with a no-equity loan, ask yourself a couple of questions:

Can you comfortably afford the larger mortgage?
Are you sure of your income, or do you have other assets you can use, other than the house, to repay the loan if your income drops?
Is there an alternative way to come up with the necessary funds? Perhaps an equity loan on a vehicle or traditional debt consolidation loan would be better alternatives?

Also consider searching out lower interest rates on your existing loans. Commonwealth Credit Union offers low rates on loans and credit cards. By transferring balances you may be able to save enough money to eliminate the need for additional housing loans.

The basic question is this: do you really need the loan? Can you adjust your lifestyle, trim your spending and do without instead of borrowing? To place your home in jeopardy to go on a vacation doesn't make good financial sense.