The real estate market is up in most places around the United States. That’s good news for homeowners who may have been under water with their mortgages for the past several years. But it also presents a trap for the unwary. That trap is called the home equity loan, also known as a home equity line of credit (HELOC) or home equity credit line (HECL). What you don’t often hear it called is a second mortgage, even though that’s exactly what it is.
Banks don’t like to call this taking out a second mortgage because that sounds so negative. Instead, home equity loans are marketed by banks as a way to “unlock the equity in your house.” Unlocking the equity sounds so good. After all, it’s your house and your equity. Why shouldn’t you be able to get at it? It’s just like making a withdrawal from savings, right?
Well, not exactly. When you withdraw from savings you have no obligation (except to yourself) to pay that money back. But when you get a home equity loan, it really isn’t your money — it’s the bank’s money and the bank now has a mortgage (that ugly word again) against your house. That means if you don’t repay the money the bank can foreclose on your home. It also means that if you face financial difficulty and are forced into bankruptcy, you still have to pay the home equity loan (and your first mortgage) to keep your house.
There might be good reasons to take out a home equity loan. Some valid reasons are to make needed improvements or repairs, such as a new addition or new roof; or to meet an unexpected emergency, such as a medical emergency. But most reasons for taking out a home equity credit line aren’t valid. They include things like that dream vacation around the world; buying a new boat because if you finance it through the house the interest is tax deductible; paying for your daughter’s wedding; or finally getting that 90″ TV that you have wanted for so long.
When it comes to home equity loans, the rule of thumb is “don’t do it.”