Property lines

Home equity lines of credit are
soaring in popularity, but they come
with risks that not everyone knows

What to look for

By Lyn Danninger

Homeowners eager to lower their monthly payments or take advantage of rising values by borrowing against the equity in their homes have been refinancing at record levels throughout the country.

Last year alone, homeowners raised $130 billion through home equity loans and lines of credit -- almost double the previous year's total, according to the Federal Reserve.

Despite more attractive interest rates and the chance for a tax deduction, home equity loans pose a risk credit cards and other consumer loans don't -- the equity loans are secured by a home. Default, and foreclosure is a possibility. At the same time, the loans are pushed by lenders as ways to finance vacations, home improvements or tuition.

In Hawaii, where home values have been on the rise for a couple of years, borrowers who were having trouble making payments or who were stuck in homes where the value had dropped below the amount of the existing mortgage are breathing a sigh of relief.

With rising home equity and a drop in interest rates, all of a sudden money can be borrowed for things like home renovation, a new car, paying off high-interest rate credit cards or paying for a child's education.

But in parts of the Midwest and Southeast, where home prices have softened, delinquencies in home equity debt have started to rise and bankruptcy lawyers are reporting that a growing number of clients are losing homes to the banks.

No figures are available for how much Hawaii homeowners are now borrowing against their homes, but local lenders say they are being kept busy.

Typically, with low interest rates, Hawaii homeowners will refinance higher-rate first mortgages, often borrowing more money to cover the cost of things like home renovation, a new vehicle or credit card debt. Refinancing can also eliminate mortgage insurance, say lenders.

"We've seen a lot of refinancing of first mortgages then they usually look at a home equity line and roll it into their first mortgage so they can take some equity out," said Lori McCarney, executive vice president, retail lending and marketing for Bank of Hawaii.

It appears Hawaii homeowners may be more conscientious than their mainland counterparts when it comes to keeping up with debt, and are likely to be more cautious in amounts they borrow, the local lenders say.

"Hawaii people are very resilient. They've been through a lot of ups and downs and cycles. Maybe they've really figured it out," said Bankoh's McCarney.

Mark Felmet, executive vice president of First Hawaiian Bank's consumer lending group, agrees.

"If you look at delinquencies in the state for all lending, it's appreciably lower than elsewhere. As far as home equity lending, we have not had any adverse experiences. In fact it's one of our better-performing portfolios," he said.

Hawaii also does not have a large subprime market, where banks lend to people with troubled credit histories.

"In Hawaii, we don't have lenders who do that a great deal. With subprime, there is more risk so you recognize that you are going to have more defaults," McCarney said.

In Hawaii, homebuyers typically pay 20 percent of the cost up front, with 80 percent financed through a mortgage, she said.

"That's pretty typical, whereas if you go to the mainland some lenders will go to 100 percent and if the home loses value, people get stuck," she said.

To capture the growing market of people anxious to capitalize on the equity in their homes and to be competitive, lenders have come up with a variety of packages.

For Wells Fargo mortgage consultant D.J. Dole, the first step is to home in on what the homeowner wants to do with the extra money.

"We try to get an idea what their needs are, such as do they have kids in school, are they about to retire. If you plan to sell the house in a few years, you may not need a 30-year mortgage," he said.

Depending on what type of loan is selected, extra charges could include an appraisal fee, an origination fee and some other up-front costs or annual fees. Margins and rates charged would depend on the homeowner's credit score and how much is being borrowed.

Typically a home equity line of credit is a form of revolving credit where the home serves as collateral and where the borrower takes money when needed. It could be for a fixed period, such as 10 years. As the balance is paid down, those funds become available again to borrow.

Many lenders set the credit limit on a home equity line by taking a percentage of the home's appraised value and subtracting from that the amount owed on the existing mortgage. At the end of the fixed period, the borrower may be allowed to renew the credit line. Typically, home equity lines involve variable interest rates and have a cap on how much the interest rate may increase over the life of the loan.

For an equity loan, a fixed amount is borrowed to be paid off over a certain period. For example, $15,000 may be due in 10 years or $30,000 due in 15 years would be typical.

Regardless of what type of home equity borrowing plan is eventually chosen, lenders say it is important for borrowers to consider how they will pay back the money. Some plans set minimum payments that cover a portion of the principal plus accrued interest.

But unlike with a typical installment loan, the portion that goes toward principal may not be enough to repay the balance by the end of the term, leaving a large "balloon" payment. Most lenders offer a choice of payment options.

Still, with lending institutions making loans easier than ever to obtain, many people may be borrowing more than they need.

There are two ways to look at borrowing money against a home, said University of Hawaii economist Byron Gangnes.

"If all they do is use that money to maintain a standard of living, then maybe that's not such a good choice," he said. "But if it allows people more flexibility in dealing with short-term debt it may be worth considering."


What to look for:

>> There is no one-size-fits-all loan. Talk to lenders about what you plan to do with the money. Most can offer a variety of options.

>> Read the terms and conditions of various plans, including the annual percentage rate and the costs of establishing the plan. The APR for a traditional second mortgage loan takes into account the interest rate charged plus points and other finance charges. The APR for a home equity line of credit is based on the periodic interest rate alone. It does not include points or other charges.

>> Consider how will you repay your home equity plan. Many lenders offer a choice of payment options.

>> If you are thinking about a home equity line of credit, you may also want to also consider a traditional second mortgage, especially if you need a set amount for a specific purpose. It provides a fixed amount of money repayable over a fixed period.

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