No Equity Home Loan

As you make payments against the principal balance on your home mortgage, you begin accumulating equity – assuming, of course, that the value of your home hasn’t plummeted. Lately, major upheavals in the real estate market have caused many homeowners to become “underwater” with their mortgages. As a result, traditional home equity loans – which are often used to consolidate debt and to fund home improvement projects – are out of the grasp of many people. In turn, many homeowners who are desperate for cash have been turning to no-equity home loans. If you’ve been considering a no-equity home loan, proceed with caution; familiarize yourself with the major drawbacks of no-equity home loans below.

What is a No-Equity Home Loan?

Unlike a traditional home equity loan – in which you essentially cash out a portion of the equity that you’ve already accumulated in your home – a no-equity home loan allows you to exceed whatever equity you have in your property. These loans are also known as high loan-to-value, or LTV, home equity loans. The loan amount of a no-equity home loan can exceed the actual value of a home by as much as 25%. As a result, homeowners are taking on debt that is secured and unsecured – and they’re putting their homes at risk.

The Disadvantages of No-Equity Home Loans

There are many disadvantages associated with no-equity home loans. A few of them include:

You’re Going to Pay More – Interest rates for no-equity home loans are typically two to six points higher than traditional home equity loans. On top of that, the fees that are tacked on tend to be significantly higher than those of regular home equity loans. As a result, you’re going to spend a lot of cash right from the start.

You’re Going to Need PMI – Since a portion of a no-equity home loan presents extra risks to lenders, it must be insured by a private mortgage insurance policy. PMI is used to cover the amount of the loan that exceeds 80% of a home’s value; it doesn’t exceed 100% of it. This means that you must insure 20% of the secured part of your no-equity home loan – and that can add 0.5% to 1% to the balance that you owe.

You’re Going to Have Trouble Selling Your Home – You could end up in hot water if you have a no-equity home loan and need to sell your home quickly. That’s because you could easily owe more on the loan than what your home is worth. Even if you get a fair price for it, you could default on your no-equity home loan and end up in foreclosure.

You’re Going to Owe More Taxes – One of the perks of being a homeowner is taking as many tax deductions as possible, in order to reduce your total tax bill. The interest on a traditional home equity loan is deductible – up to $100,000, for married couples filing joint returns. However, any interest that is paid on the portion of a loan that exceeds the value of a home is not deductible. You could end up with a nasty surprise on April 15, so keep that in mind before signing up for a no-equity home loan.

As you can see, no-equity home loans come with a lot of fine print. Do your research and be very careful before committing to one.