The lender's security for the loan is your home, meaning if you go into default and do not make your mortgage payments or otherwise abide by the terms of the loan, the lender has the right to foreclose. In many states, like California, if a homeowner stops paying the first lender, to protect its security, the second-position lender can step in, make up the payments to the first lender and begin its own foreclosure proceedings. All of which means your home is at risk when you take out a home equity loan.
Bridge loans are used by sellers who want to buy a new home before selling an existing home but need the cash from the existing home. You will see bridge loans used more often in seller's markets than in buyer's markets. Common terms for a bridge loan are:
- Loan amounts up to 80% of market value
- Higher loan costs such as points or admin fees
- No payments for 3 to 4 months
- Right to renegotiate loan terms if home does not sell within loan term
- Some lenders demand the borrower obtain the financing for their new home from the lender making the bridge loan
Home Equity Loans
Borrowers cannot obtain equity loans in all 50 states. Equity loans can be used toward the purchase price of a new home but the lender will not make the loan if your home is on the market. This is the main reason many sellers obtain bridge loans instead. But since costs are higher with a bridge loan, it makes more sense to get an equity loan if you can plan far enough in advance.
Borrowers also obtain home equity loans to pay for home improvements / remodeling, college education or medical expenses. Because interest is tax deductible on a home equity loan, many homeowners choose to borrow against a residence to buy consumer goods. They reason that if they finance consumer goods by obtaining an unsecured loan or putting the purchase on a credit card, they cannot deduct the interest, but they often do not stop to consider whether the item is really a necessity. It is not a good idea to borrow against your home to purchase luxuries such as motor homes, ski boats or vacations, but people do it. Advantages to a home equity loan are:
- Typically, fixed rate of interest
- Borrow 100% of equity or more
- Amortized payments
- Longer loan terms such as 3, 5, 7, 10 or 15 years.
Home Equity Line of Credit (HELOC)
Borrowers can take out a home equity line of credit and never repay a dime. That's because a HELOC is a line of credit, meaning if you never actually take any of the money available, you won't ever need to pay it back. It's available by writing a check for more than you have in your account or by making withdrawals against a specific account at your lending institution.
Some of the characteristics inherent with a HELOC are:
- Generally, an adjustable-rate loan
- Once the money has been repaid, you can borrow it again
- Flexible payment terms, sometimes as low as 1% of your loan balance
Note: The time to apply for a HELOC is when you don't need it. It's credit that will be available to you should you ever need to draw on it, whether you are subsequently unemployed or facing an immediate financial emergency.
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.