Home equity loans – why they are largely misunderstood

Read more: Tapping home equity has become all the rage

Home equity loans are taken to fulfill a wide variety of needs, Maloof explained: “While I can’t speak for people’s unique lending needs, some traditional reasons people take out home equity loans are to fund home renovations or cover the cost of major life events. How a borrower uses the funds from a home equity loan can have tax implications, and it is important that a lender is able to provide appropriate guidance. “

Despite their growing popularity, a great number of people don’t fully grasp the intricacies of home equity loans. Among the survey findings:   

• 48% of respondents scored their understanding of a home equity loan below a 7 out of 10. 
• 13% had no understanding at all (scoring a 1/10). 18% reported having a complete understanding (scoring a 10)  
• The average response was a 6.3 out of 10 
• Although those under the age of 55 are more likely to take out a home equity loan in the next 12 months, they are less knowledgeable about how home equity loans work (30% scored a 1/10) compared to those over the age of 55 (only 9% scored a 1/10). 

• Those in the Northeast are more likely to take out a home equity loan this year (31%) compared to Midwest (22%), South (18%) and West (19%)  
• Those living in urban areas say they are more likely to take out a home equity loan (36%) in the next 12 months compared to those living in rural or suburban areas.

Tim Wheeler, vice president, corporate lending at Fortera Credit Union, expounded on the widespread lack of understanding as it relates to home equity. “Home equity loans and lines of credit typically have terms, disclosures, and fees not associated with other forms of consumer credit,” he told MPA. “While closed end home equity loans share characteristics with first mortgage products, which are more familiar to consumers, they’re not as common as other forms of credit. Home equity lines of credit can have varying payment types” he said, citing fixed payments or interest only as examples, “draw periods, and maturity. Borrowers should take extra care to ensure they understand the specific terms before proceeding.”

Consumers should also be aware of potential pitfalls: “Using equity may cause additional risk if the borrower decides to sell the property in the future,” he said. “Depending on the combined loan to value position, they may not realize the net gain/profit they were expecting. An additional risk would be using equity built over time to pay routine, recurring expenses as opposed to, say, paying off higher interest debt or making a single major purchase (such as a home improvement or repair). Equity lines and loans should be carefully managed as part of the overall budget of the borrower. Lenders should offer educational tools and programs to assist borrowers who encounter financial hardship.”