Tapping home equity can be a lifeline as emergency savings dry up for many Americans during the coronavirus pandemic. Closing quickly on a home equity loan is easier now, but approval may be harder as lenders seek to limit risk.
A new rule from the Consumer Financial Protection Bureau speeds up home equity loan closings if homeowners are struggling because of the COVID-19 crisis. But the pandemic has led some lenders to pause applications for home equity loans, and others have enacted stricter lending standards. A surge in layoffs, furloughs and reduced hours could make qualifying for loans tough for consumers.
If you've built home equity and face pandemic-induced financial strain, here's what to consider before you apply for a home equity loan.
[Read: Best Home Equity Loans.]
Pros and Cons of Home Equity Loans
Home equity loans can be used for just about anything, from consolidating debt to making home improvements and covering emergency expenses. But the pros and cons of a home equity loan are generally the same no matter how you plan to use it.
Benefits of a home equity loan:
-- Fixed payments. Because a home equity loan is an installment loan with a fixed interest rate, your monthly payments are predictable over the life of the loan. This can help you plan your budget.
-- Lower interest rates compared with credit cards and personal loans. That's because home equity loans are secured, so they're less risky for lenders compared with unsecured debt. And if you pay off the home equity loan early, you stand to save even more on interest costs.
-- Tax deductions. If you use the home equity loan for eligible home improvements, you may get a tax deduction on interest payments.
Drawbacks of a home equity loan:
-- Certain lenders aren't taking new applications. Some large lending institutions are "pumping the brakes on equity lending altogether" to avoid risk, says Melinda Opperman, president and chief relationship officer at Credit.org, a nonprofit credit counseling agency. Other lenders are still offering these loans but are tightening eligibility standards or reducing the amount you can borrow. You'll likely need good credit to qualify, and the lender will verify your income and how much home equity you have.
-- You risk foreclosure. A home equity loan is secured by the equity in your home. If you fall behind on payments, the lender may start foreclosure proceedings on your home. Taking one of these loans is especially risky in an unstable job environment. The U.S. unemployment rate hit a high of 14.7% in April, according to the Bureau of Labor Statistics, which represents the worst jobless count since the Great Depression. The jobless rate in June stood at 11.1%.
-- Your equity drops. You won't get back the equity you lost until you pay off the loan. In the meantime, "If property values drop due to the pandemic, people holding home equity loans will be very hard-hit," Opperman says. You may end up owing more on the home equity loan than your home is worth. Luckily, changes in property value tend to be minor and temporary.
[Read: Best Debt Consolidation Loans.]
How to Speed Up Your Home Equity Loan Closing
If you have a coronavirus-related financial emergency, the Consumer Financial Protection Bureau states that you may be able to hasten the home equity loan closing process. But you would give up some consumer rights in the process.
The CFPB's rule clarifies that you may:
Waive or shorten waiting periods. You may be able to skip or shrink certain waiting periods required between the time you receive important loan documents and when you close on your home equity loan. Those documents are the loan estimate and the closing disclosure.
The loan estimate explains your loan's interest rate, monthly payment and closing costs, while the closing disclosure outlines your loan's final details. Borrowers receive the loan estimate at least seven days before closing and the closing disclosure at least three days beforehand.
If you want to expedite these waiting periods, you must give your lender a brief written statement explaining your financial emergency and its connection to COVID-19. You'll need to state that you are waiving or modifying the waiting periods.
You and anyone else on the loan will need to sign and date the statement.
Waive your right to rescind. This means you lose your right to cancel the transaction, unless there is proof of fraud. Normally you would have three days to tell the lender if you changed your mind.
You may waive the right to rescind if you have an emergency and need funds quickly.
"The obvious benefit to waiving these rights is speed," Opperman says. "If you have a truly urgent emergency and can't wait a week or more for the money you need, waiving these rights can get you the funds fast."
The waiting periods and the right to rescind are meant to protect consumers. They give borrowers time to read through the loan terms, ask questions and have an attorney review the documents.
A home equity loan is considered a second mortgage, and lenders follow some of the same processes they would for a first mortgage.
"If you've ever purchased a home, you know it's not just one sheet of paper," says Bola Sokunbi, certified financial education instructor and founder of Clever Girl Finance, a personal finance website for women. "You're getting a really hefty legal document. When you waive (the waiting periods) to accelerate getting the loan payment, you don't get a chance to review that information."
[Read: Best Personal Loans.]
Alternatives to a Home Equity Loan
Homeowners often turn to home equity loans during a crisis, Opperman says. But because of the risks involved, she says, "We really want people to think twice and come up with a better option."
Here are some alternative ways to borrow money or otherwise work through a financial pinch:
Forbearance programs. If you're struggling, talk with your lenders about hardship programs right away. "You might not need to go into debt if your lenders are willing to work with you," Sokunbi says.
Although they might not propose them immediately, relief options are available from many lenders during the pandemic. Credit card issuers, utility companies and many banks may be able to reduce or pause monthly payments or waive late fees.
Personal loan. A personal loan may come with a higher interest rate than a home equity loan, but the former is typically unsecured, meaning no collateral is at risk. Missed payments would hurt your credit, "but you wouldn't lose your home because you lost your job and you're unable to make the payments," Sokunbi says.
A coronavirus hardship loan is one type of personal loan that has emerged from many credit unions and some banks.
It is usually packaged as a small, short-term loan that comes with consumer protections. You may even be able to get a 0% interest rate and defer payments for up to 90 days.
Home equity line of credit. As with a home equity loan, a HELOC allows you to borrow against the value of your home. But it works like a credit card, so you don't take out money until you need it.
During the draw period, you can borrow money, pay down your balance and repeat. But proceed with caution.
A line of credit may help you feel financially insulated, but it is a false sense of security because you risk losing your home if you fall behind on payments.
401(k) loan. If your employer offers a 401(k), it may also allow you to withdraw money as a loan you pay back later. Recent legislation doubles the amount you can borrow from your retirement savings: up to 100% of the vested balance or $100,000, whichever is less.
If you decide to borrow against your 401(k) balance, you will need to take out the loan by Dec. 31 and repay it within five years.
Borrowing might make sense if you need the money and your income is stable enough to repay the home equity loan. But there are risks.
You could lose your home if you can't make payments. And you may end up underwater on the loan if home prices fall.
"We advise caution," Opperman says. "Keeping your homeownership stake intact is a very safe place to store the wealth you've built up. Even if there's another housing crash, you still have a roof over your head."
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