4 Mistakes First Time Homeowners Make Taking Out a Home Equity Loan
First time homeowners are overwhelmed with offers for home equity loans immediately after taking a mortgage. Credit cards and other offers come in the mail for first-time buyers with great speed in order to entice them to spend more money on their property. While it does make sense to use your equity in order to build your assets further, you should be cautious when taking any home equity loan to avoid common mistakes.
#1 Over-Mortgaging a Property
The number one mistake first time homeowners make with their property is over-mortgaging it. An over-mortgaged property is one that has lost the vast majority of its value in equity. This means, instead of growing the equity you have in your home over time, you are actually collateralizing the majority of it. You may own less in your home than you actually owe in debt. Before taking any home equity loan, first assure you have sufficient equity in your home. Then, assure your equity to debt ratio is never less than 2:1 on the property.
#2 Not Considering Foreclosure
Many homeowners do not realize they can suffer a foreclosure if they default on a home equity loan. Your primary mortgage lender holds the deed to your house. If your primary mortgage is in good standing, you may feel secure in your property. However, defaulting on a subordinate loan can threaten even this loan in good standing. Your secondary lender can buy your primary mortgage. Then, the secondary lender can force you into a foreclosure situation, taking ownership of your house in order to gain repayment on the home equity loan.
#3 Spending on Less Valuable Improvements
The majority of home equity loans go back into the house. This means they are spent on improvements and modifications to the property. While the goal of this plan is usually to build the equity you have in your own property and the value of your asset, not all changes actually add value. Many first time homeowners want to spend money customizing or upgrading the property when they should actually be making more practical improvements.
For example, replacing roofs, doors and windows is one of the most valuable investments you can make in a home. Replacing lighting, insulation and electrical is another value-adding change. Many new homeowners will opt for a flashier improvement, like adding a pool or an addition, instead of focusing on what makes the most financial sense.
#4 Allowing Interest to Compound
A large amount of home equity loans are actually distributed as home equity lines of credit. In fact, many mortgage lenders extend a home equity credit card along with an initial mortgage. This revolving debt is very flexible, allowing home owners to choose how much financing to use and when to pay it down. Without discipline, though, these borrowers can end up allowing interest to compound on balances that extend month to month instead of paying off balances regularly. The cost of financing revolving debt between months greatly increases the expense of any purchase made with funds from the home equity line.