Home Equity Loans converting to Second Mortgages

Getting a fix on home equity loans
Patricia Simms 608-252-6492, Wisconsin State Journal http://www.madison.com/wsj/home/biz/index.php?ntid=102108&ntpid=1 
psimms@madison.com

SOURCE: Federal Trade Commission

Web site: www.ftc.gov
Retired Madison La Follette teacher Martha Reinke and her husband, Richard, watched as the interest rate on their home equity line of credit with US Bank slowly escalated.

They'd originally taken out the loan four or five years ago to repair their Virginia Terrace home.

Lines of credit were cheap then, and tied to the prime rate, not so cheap now at 8.25 percent.

Wednesday, Reinke said she walked into US Bank at Hilldale and noticed a special.

She could convert the adjustable rate line of credit to a fixed rare loan at a lower rate than she was paying.

She signed up. "We are on a fixed income," Reinke said, "and I wanted to know exactly how much I was going to be paying every month. I found it very difficult to budget (without that), and it made economic sense to be paying anywhere from 2 to 4 percent less than we were paying."

While bankers say the recent fever to tap home equity has cooled, new fixed-rate offerings are attracting homeowners to convert adjustable rates to more predictable payments.

The amount of home equity loans outstanding held by commercial banks in Wisconsin jumped from $2.8 billion in June 2002 to $5.3 billion in June 2006 — a 90 percent increase.

But climbing interest rates are forcing consumers to look for fixed rates on their second mortgages.

"Because the rates have gone up so much and people fear that it might continue, my objective right now is to put people into a fixed situation," said Betsy Hessel, vice president of Union Federal Savings And Loan Association in Madison.

That means home equity loans with fixed payments for five to 30 years, a fixed interest rate and at least a small amount going to pay off the principal every month, she said.

Fritz Elmendorf, vice president of communications at the Consumer Bankers Association in Virginia, said conversions allow consumers to convert all or part of their adjustable rate balance to a fixed rate.

"It's been a very popular feature for a few years with a lot of banks," Elmendorf said. "Some have promoted the feature actively to try to retain customers who might otherwise close down the line in favor of another fixed-rate product."

US Bank is one. Jeff Boudreau, Hilldale branch manager, said the bank is promoting the popular product that allows customers to convert money borrowed under an adjustable rate home equity line of credit to a fixed-term loan for up to 20 years.

"Essentially, you are locking in a portion of the borrowed money at a fixed rate to be paid back in principal and interest," Boudreau said.

Consumers might like having the flexibility of a home equity line of credit. "But you are concerned that rates are rising. So are your payments," he said.

The new loan would pay off the home equity line of credit at a fixed rate "and leave the rest available for the future," Boudreau said.

But don't get confused about dipping into your home's value. The market has always offered home equity loans and home equity lines of credit.

A home equity loan — also called a second mortgage — typically provides a lump sum, sometimes at a fixed rate, said Elmendorf.

By contrast, a home equity line of credit — or HELOC — provides a revolving credit line, much like a credit card and usually at a variable rate tied to an index, said Carrie Templeton, spokesman for the Wisconsin Department of Financial Institutions. "As the Federal Reserve has raised interest rates to keep inflation in check, these indexes are higher than they were five years ago and one year ago," Templeton said.

So much so that rates on home equity lines of credit are higher versus one and five years ago, while rates on fixed-rate home equity loans are lower than five years ago, said Greg McBride, senior financial analyst for Bankrate.com., an Web-based aggregator of financial rate information.

For example, five years ago, a home equity line of credit was available for an average rate of 6.35 percent compared with 8.7 percent for a second mortgage, according to Bankrate.com. Today, a home equity line of credit will cost 8.21 percent compared with 7.91 percent for a home equity loan.

Some banks, eager to keep their customers, are offering to convert HELOC adjustable rates to fixed-rate, fixed-term loans, Elmendorf said, and it's quickly catching on.

"The fixed rate has become much more relatively popular because often the fixed rate is lower than the variable rate," Elmendorf said, "and it is, of course, fixed, which saves you from concern about ever-rising interest rates."

Elmendorf said there's been a 20 percent growth in home equity lending over the last three years, but the activity has probably peaked, at least for a while.

"A lot of this growth was clearly fueled by rising property values," he said, "and that has clearly cooled off or come to an end. So people are no longer feeling like they have this windfall they can tap into."

Patrick O'Brien, senior vice president and Madison district retail sales manager at M&I Bank, said this is a typical economic cycle.

"It may seem unusual due to the prolonged low interest rate environment we experienced over the last several years, but expansion and contraction of economic activity has always been the norm," O'Brien said.

"Banks will also notice a product shift from home equity lines of credit to home equity loans in a rising rate environment as homeowners prefer to lock in interest rates rather than risk higher floating rates.

Most experts say home equity lending is still a good deal for consumers.

"Whether a home equity loan ... is a 'good borrowing opportunity' depends on the borrower's circumstances," said Kurt Bauer, president of the Wisconsin Bankers Association.

He said home equity loans are popular because it is a relatively easy way for a homeowner to obtain a shorter-term loan using the accumulated equity from the dwelling as collateral.

"The other advantage is that interest paid on home mortgages is deductible," Bauer said.

And while home values are cooling, Bauer said Wisconsin has not experienced a housing bubble.

"So while home values may not be rising as fast as in previous years, there is still solid appreciation in most markets. That is certainly true in the Madison area," he said.

Consumers have to be wary, experts say. "Borrowers must still evaluate the purpose of the borrowing," McBride said.

"Regardless of interest rates or the performance of home prices, if home equity borrowing is used to fund excessive spending, then it is a bad idea. The consequences of default are very high and borrowers rob themselves of equity that is the bulk of wealth for most households."


HOME EQUITY TIPS

DON'T

• Agree to a home equity loan if you don't have enough income to make the monthly payments.

• Sign any document you haven't read or any document that has blank spaces to be filled in after you sign.

• Let anyone pressure you into signing any document.

• Agree to a loan that includes credit insurance or extra products you don't want.

• Let the promise of extra cash or lower monthly payments get in the way of your good judgment about whether the cost you will pay for the loan is really worth it.

• Deed your property to anyone. First consult an attorney, a knowledgeable family member or someone else you trust.

DO

• Ask specifically if credit insurance is required as a condition of the loan. If it isn't, and a charge is included in your loan and you don't want the insurance, ask that the charge be removed from the loan documents. If you want the added security of credit insurance, shop around for the best rates.

• Keep careful records of what you've paid, including billing statements and canceled checks. Challenge any charge you think is inaccurate.

• Read all items carefully. If you need an explanation of any terms or conditions, talk to someone you can trust, such as a knowledgeable family member or an attorney.

• Consider all the costs of financing before you agree to a loan.

Posted by Mark Rodrigues at 10/20/2006 6:39 PM
Categories: Mortgage, Home Equity Loans, Lending
 

What did you think of this article?




Trackbacks
Trackback specific URL for this post
  • No trackbacks exist for this post.
Comments
  • No comments exist for this post.
Leave a comment

Submitted comments are subject to moderation before being displayed.

 Name (required)

 Email (will not be published) (required)

 Website

Your comment is 0 characters limited to 3000 characters.