Seduction Of Home Equity Loans Destroys Your Wealth

By on June 17, 2013

You are sure to have notice the advertisements broadcasting low mortgage rates that apply to home equity loans. They are everywhere. You could have seen them on television, heard them on radio, read about them on newspapers, or even swiped them on your Android phone on social media. Market players have long championed the seemingly basic wealth accumulation strategy of home equity loans. Savvy real estate investors have been applying these strategies for years. But it was in the last decade where the concept of cashing out your property to buy more properties really caught on in the mainstream.

And if you talk to bankers, they are sure to tell you how useful those additional funds are for your personal use or investment use. But as this trend starts to take hold, we could be seeing more and more people owing more money than what their property is worth. They have unknowingly signed on to a lifetime of debt.

Just one generation before the Gen-X, home owners are not investors and annually count down the number of years until they fully pay off their home and own the house outright. The financial objective was to be debt-free. Taking on additional debt through home equity is as unmentionable as the plague. How times have changed. These days, the objectives of home buyers is to maximize leverage due to the championing of financial savviness concepts. Other People’s Money or OPM is the catch phrase these days.

But at some point in an advancing mature economy, corporations start alienating their self-imposed role as financial watchdogs and become solely profit-driven. The argument is that people are now savvy enough to look after their own financial activities. So rather than counsel the market against the dangers of over borrowing, you can now get a credit card mailed to you without ever seeing a real banker in person. The job of counseling now lies with government agencies.

HEL-page-001The relentless advertisements we see on “gurus” teaching up how to own 20 properties with no money down does not help. It seems as if that as long as you own a home, there is a pre-approved equity loan waiting for you to withdraw. It is no wonder a potential property bubble is brewing in Singapore. People are buying up multiple homes with staggering leverage. The increasing prices boost values of existing homes. Owners of these homes then take up maximum leverage again on equity loans to buy more properties. And the result is that genuine home buyers who are buying their first property for occupation are being priced out of the market.

The seduction of more money is as tempting as a chocolate cake at Bakerz Inn. But a home equity loan handicaps your ability to build wealth if you do not use the extra funds for investments with little risks and attractive returns. Using these monies on luxuries like a pool table, a fancy sports car, or one-month European tours. It is not a crime to pamper yourself with lavish indulgence. But if you intend to build your wealth, spending on these luxuries is the best way to squander your home equity.

You might have also fell for the seduction of loan consolidation via home equity loans with low interest rates. This means that you will use the funds from home equity to pay off your personal loans, cashlines, other debts, etc. But often times, you will find that you are going to be paying more interest in the long term. This is because although you lower the monthly payments you have to make in the short term, the long term nature of equity loans mean that you will be servicing the loan for a much longer tenor. And if you continue to intensify your spending spree, you might also end up taking up more loans as your property value increases.

I still have to cash out with a home equity loan

If you are still insistent on getting a home equity loan after the above ramblings, remember to scrutinize the terms of your new loan. By going this route, you are effectively refinancing your existing mortgage and taking up a bigger loan this time. And since there is a high likelihood that you will be switching banks, approach accepting this new loan with the same eagle eye you had on the first loan. Lenders usually advertise their best interest rates and only leave the terms and conditions that the loan is subject to before you sign up for it. You could call this sneaky. But at least they have the responsibility to inform you of these terms and conditions before you formally accept their offers. You can always back off as long as you have yet to sign on the dotted line.  There are many businesses out there that does not even tell you exactly what you are signing up for.

Here are some of the key terms to scrutinize:

1) Interest rates. What is the fixed rate that you are eligible for? Compare that with floating rates which is most likely to be pegged to SIBOR or SOR plus a spread. Is there a cap on interest rate? If a loan packages is extremely low in the initial years, what are the rates after these initial years?

2) Fees and charges. Low interest rates often come with a lock-in period of the loan. This means that if you are to redeem your loan within the lock-in period, you will incur a penalty fee. Many bank can offer the option to make partial redemptions without penalties as long as you do not make a full redemption. Other fees to scrutinize are cancellation fees, conversion fees, valuation fees, etc.

3) Re-pricing. Many lenders may also offer you an option to re-price the loan at a specified time. For example, the contract may say that 1 year from acceptance, you will have the option of exploring repricing without charges.

4) Inactivity. You may not be using all the funds at once or just leaving the cash in your account for rainy days. It could also be that you did not go through with the investment you had planned for the funds in the first place. In some cases, you can keep those funds in a special account with the lender that offsets the interest you have to pay for the home equity loan.



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