Seniors and Home Equity Lines of Credit

The headlines are everywhere. People of all ages and in all walks of life are losing their homes because of risky borrowing practices. Predatory lending is partly to blame, of course. But for many seniors, the biggest risk factor for losing their home may well be “treating your home like an ATM” —tapping into your home’s equity to help make ends meet or buy things you want or help out your family. How does this happen?

Simply put, the ready availability of home equity lines of credit (HELOCs), rising interest rates, minimum payments, and lack of consumer understanding of complicated loan products combine to create potential financial problems.

The perils of a home equity line of credit

Many lenders will allow you to borrow as much as 125 percent of your home’s value—25 percent more than your home is theoretically worth. But they don’t stop there. When you combine this “loose lending” practice with another dangerous practice—that of “over-appraising” a home’s value—you can quickly end up with loans that reach or even exceed your home’s value by 25 to 50 percent or more.

Here’s a possible scenario:
You own a home that would sell for about $300,000 (based on comparable sales this year).
You own your home free and clear.
You get an offer (in the mail, via a phone call, or from your bank, for example) for a home equity line of credit.
You have the appraisal done—and it comes back at $320,000.
The lender then offers you a 125 percent HELOC—meaning you can access up to $400,000 (the $320,000 appraised value plus 25 percent of that amount -- $80,000) on a home that would only sell for about $300,000.

This is a recipe for disaster. Along with this inflated HELOC come checks and a “credit card” to access these funds as you wish. There are repayment requirements, but normally only for the interest, so your loan principal never goes down. And the interest rate is “adjustable,” so it is very likely to rise for at least the next few years. You have a “balloon” loan—one that is due in full at some point in time—for an amount that is well above what your home will bring when it is sold.

A well-managed HELOC—one where you stay well below your home’s real sales price—can be a good thing. The unpaid principal can be settled when you sell the home, or by your heirs during probate. On the other hand, an excessive HELOC, as in the example above, is a dangerous way to access the equity tied up in your home, consolidate debt, or supplement your income.

A possible solution

If you are at least 62 and you either own your home outright or have a small mortgage (less than 20 percent of your home’s value), talk to your financial advisor about options such as a reverse mortgage.

And please remember—your home is not an ATM. Eventually that convenient HELOC has to be paid back (or your home may be forfeit). And worst of all, you may end up owing far more than your home is worth.

For more information:

www.lendingtree.com: Lending Tree, a network of major lenders and realtors, offers a consumer website with free information, including a tutorial on HELOCs and the opportunity to get competitive loan offers at no obligation.
www.investopedia.com(Investopedia) and www.fool.com(The Motley Fool) are online magazines (“ezines”) with information on a variety of financial topics, including HELOCs, debt consolidation and refinancing. (At both websites, enter “HELOC” in the Search window at the top of the page.)
http://money.howstuffworks.com/home-equity-loan1.htm: for the article, How Home Equity Loans Work.