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Reasons to Avoid a No Equity Home Improvement Loan


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TERMINOLOGY

Avoiding a no equity home improvement loan may be in the best interest of all borrowers. These types of loans can be potentially dangerous. These loans are for those looking to take advantage of being a homeowner, without having to meet the credit, security or collateral requirements of other loans. However, the credit crisis that was created by poor decisions and unethical loan practices serves as a warning of what may happen when individuals with no understanding of how money works enter into these arrangements.

No Equity Home Improvement Loans

A no equity home improvement loan is one that provides excess funds to a borrower that is beyond the available equity. They can be referred to as 125 percent loan-to-value (LTV) home equity loans and used for any purpose by the borrower. The loan becomes a second loan, subordinated to a homeowner’s primary mortgage.

The collateral of this loan results in an increase of debt for the borrower and the potential for financial calamity similar to the subprime mortgage crisis. Since a property in a good market can only be sold for 100 percent of its value, lending more than the value of a home is a recipe for disaster. Recently, we have suffered a bad real estate market, which means that property values have decreased. For a 125 percent LTV loan, the original value is even lower, leaving banks and borrowers in even more trouble.

Risks Associated

No equity home improvement loans, like other high value LTV home equity loans, are risky because a borrower takes on a higher payment. If the borrower is not properly prepared for the new payment, the possibility of foreclosure or default is high.

Also, taking out these loans can mean that the borrower has a combination of secured and unsecured loans that if not paid back, could lead to home foreclosure and loss of primary residence. The risks associated with these types of loans in most cases outweigh the benefits that are touted by the lender.

No Equity Loan Interest Rates

Interest rates that are associated with no equity home improvement loans are very high, relative to a comparable traditional home equity loan. The rates on a no equity home improvement loan can run 6 or 10 points higher than traditional loans. Also, there are other fees associated with the loan that need to be taken into account. These fees alone can be $10,000 or more.

Difficulties Selling Home

A no equity home improvement loan may also make selling the home difficult. A home with a mortgage value of $500,000 that the homeowner takes a 125 percent LTV home equity loan on for home improvement purposes may find they need to sell the house for $600,000 to break even.  In a declining housing market trying to gain traction because of the subprime mortgage debacle, borrowers could potentially find themselves on the negative side of the sale result and needing to come out of pocket for the difference in order to avoid bankruptcy.