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Need a Loan?
Think Twice About Using
Your Home as Collateral

If you need money to pay bills or make home improvements, and think the answer is in refinancing, a second mortgage, or a home equity loan, consider your options carefully. If you can't make the required payments, you could lose your home as well as the equity you've built up. That's why it's important not to let anyone talk you into using your home to borrow money you may not be able to afford to pay back. Not all loans or lenders are created equal. Some unscrupulous lenders target older or low-income homeowners and those with credit problems. These lenders may offer loans based on the equity in your home, not on your ability to repay the loan. High interest rates and credit costs can make it very expensive to borrow money, even if you use your home as collateral.

Talk to an attorney, financial advisor, or someone else you trust before you make any decisions about borrowing money. Non-profit credit and housing counseling services also can be useful in helping you manage your credit and make smart decisions about loans.

Early Warning Signs

Avoid any lender who:

  • tells you to falsify information on the loan application. For example, stay away from a lender who tells you to say that your income is higher than it is.

  • pressures you into applying for a loan or
    applying for more money than you need.

  • pressures you into accepting monthly payments
    you can't make or could have trouble making.

  • fails to provide required loan disclosures
    or tells you not to read them.

  • misrepresents the kind of credit you're getting,
    like calling a one-time loan a line of credit.

  • promises one set of terms when you apply,
    and gives you another set of terms to sign
    — with no legitimate explanation for the change.

  • tells you to sign blank forms — and says they'll
    fill in the blanks later.

  • says you can't have copies of the documents
    that you've signed.

You can take some steps to protect your home and the equity you've built up in it. Here's how.

1. Shop Around. Costs can vary greatly.

Contact several lenders — including banks, savings and loans, credit unions, and mortgage companies. Ask each lender about the best loan you would qualify for. Compare:

  • The annual percentage rate (APR). The APR is the single most important thing to compare when you shop for a loan. It takes into account not only the interest rate, but also points (one point equals one percent of the loan amount), mortgage broker fees, and certain other credit charges the lender requires the borrower to pay, expressed as a yearly rate. Generally, the lower the APR, the lower the cost of your loan. Ask if the APR is fixed or adjustable — that is, will it change? If so, how often and how much?

  • Points and fees. Ask about points and other fees that you'll be charged. These charges may not be refundable if you refinance or pay off the loan early. And if you refinance, you may pay more points. Points usually are paid in cash at closing, but may be financed. If you finance the points, you'll have to pay additional interest, increasing the total cost of your loan.

  • The term of the loan. How many years will you make payments on the loan? If you're getting a home equity loan that consolidates credit card debt and other shorter-term loans, remember that the new loan may require you to make payments for a longer time.

  • The monthly payment. What's the amount? Will it stay the same or change? Find out if your monthly payment will include escrows for taxes and insurance.

  • Balloon payments. This is a large payment usually at the end of the loan term, often after a series of lower monthly payments. When the balloon payment is due, you must come up with the money. If you can't, you may need another loan, which means new closing costs, as well as points and fees.

  • Prepayment penalties. Prepayment penalties are extra fees that may be due if you pay off the loan early by refinancing or selling your home. These fees may force you to keep a high-rate loan by making it too expensive to get out of the loan. If your loan includes a prepayment penalty, understand the penalty you would have to pay. Ask the lender if you can get a loan without a prepayment penalty, and what that loan would cost. Then decide what's right for you.

  • Whether the interest rate for the loan will increase if you default. An increased interest rate provision says that if you miss a payment or pay late, you may have to pay a higher interest rate for the rest of the loan term. Try to negotiate this provision out of your loan agreement.

  • Whether the loan includes charge for any type of voluntary credit insurance, like credit life, disability, or unemploy-ment insurance. Will the insurance premiums be financed as part of the loan? If so, you'll pay additional interest and points, further increasing the total cost of the loan. How much lower would your monthly loan payment be without the credit insurance? Will the insurance cover the length of your loan and the full loan amount? Before you decide to buy voluntary credit insurance from a lender, think about whether you really need the insurance and check with other insurance providers about their rates.

You'll also want to ask each lender to provide, as soon as possible, a written Good Faith Estimate that lists all charges and fees you must pay at closing. Ask for a Truth in Lending Disclosure, too. It states the monthly payment, the APR and other loan terms. Although lenders are not always required to provide these estimates, they're very helpful because they make it easier to compare terms from different lenders.

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