Mortgages & Refinancing

NASD Alerts Firms About Liquefied Home Equity Concerns

Notice Reminds Firms That Using Home Equity for Investments Not Always Suitable

WASHINGTON, Dec. 8 /PRNewswire/ -- Concerned about the increasing number
of investors who are turning home equity into cash to make investments, NASD
today reminded regulated firms of their obligation to perform a careful suitability analysis before recommending such a strategy to an investor.
"Many homeowners have become wealthier -- at least on paper -- because of
escalating home values. And more of them than ever before are tapping into
their increased home equity to purchase securities," said NASD Vice Chairman
Mary L. Schapiro. "But turning equity into cash to make financial investments
isn't an appropriate strategy for many investors. That strategy poses
significant and unique risks, and failure to understand those risks could cost
them their biggest asset -- their home."
NASD spelled out its concerns and its recommendations to regulated firms
in Notice to Members 04-89: Liquefied Home Equity. In March, NASD issued an
Investor Alert on the subject, Betting the Ranch: Risking Your Home to Buy
Securities. In May, NASD issued a related Investor Alert on the risks
associated with pledging securities in lieu of a mortgage down payment, 100%
Mortgages: The Low Down on No Money Down.

The concerns outlined in the Notice to Members issued today include:

* The increasing use of home equity for investments. In addition to its
own observations, NASD cites a Federal Reserve Board study that found
that during the most recent period it reviewed -- 2001 through the
first half of 2002 -- 11 percent of the total funds from mortgage
refinancings were used for stock market and other financial
investments. That's up from less than two percent during the previous
period studied, 1998 through the first half of 1999. The average
amount of cashed-out home equity individuals used for investments also
increased substantially -- from "relatively small amounts" in the
1998-1999 period to more than $24,000 in 2001-2002. The average
amount used for investments was greater than nearly all other
categories, including home improvement.

* An investor may lose his or her home if the return on investments is
not sufficient to cover the new mortgage or line of credit
obligations. Or, if the value of an investment decreases, the
investor may need to sell his or her investments to protect his or her
home and limit further losses.

* Investors may fail to recognize potential conflicts of interest, such
as a broker's interest in generating commissions or fees on
investments from the cash proceeds of a refinancing or home equity
line of credit -- or the firm's interest in generating compensation
for itself or an affiliate for originating and/or servicing the new
mortgage or line of credit.

* Cashing out home equity may undermine the asset diversification
benefit of home.

The Notice to Members issued today recommends that, in addition to the
factors typically considered as part of a suitability analysis, regulated
firms also consider the amount of equity the investor has in his or her home;
the level of equity being liquefied for investments; how the investor will
meet his or her increased mortgage obligations; whether the new mortgage or
home equity loan is at a fixed or variable rate; the investor's risk tolerance
with respect to the funds being invested; the investor's overall debt burden,
and the sustainability of the value of the investor's home.
NASD's Notice to Members also includes "best principles" for disclosing
relevant risks and conflicts, including: the potential loss of one's home; the
fact that unlike other potential lenders, the recommending firm has an
interest in having the proceeds of the loan used for investments that may
generate commissions, mark-ups or fees for the firm; the recommending firm or
its affiliate may earn fees in connection with originating and/or servicing
the loan; the impact of liquefied home equity on the ability to refinance a
home mortgage, and the possibility that a change in home value could result in
negative equity in the home.
The Notice to Members also recommends that firms consider whether to
establish general standards for when a recommendation to invest home equity
proceeds should be prohibited -- for instance, when an investor wishes to use
home equity for particularly risky investments, or wants to withdraw home
equity above a specific threshold.
Investors can obtain more information about, and the disciplinary record
of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck.
NASD makes BrokerCheck available at no charge to the public. In 2003, members
of the public used this service to conduct more than 2.8 million searches for
existing brokers or firms and requested almost 180,000 reports in cases where
disclosable information existed on a broker or firm. Investors can link
directly to BrokerCheck at http://www.nasdbrokercheck.com. Investors can also
access this service by calling 1-800-289-9999.

Home Equity Line of Credit vs. Home Equity Loan

The Reporter.com has a good article exploring the options of Home Equity Lines of Credit, Home Equity Loans, and other refis:

There are compelling reasons to take out a home equity line of credit or home equity loan, said Sue Rainwater, president of the East Bay chapter of the California Association of Mortgage Brokers, said. Rainwater is a broker at San Ramon's CMG Mortgage Services.

First, it's important to note the distinction between the two. A home equity loan is for a fixed amount. A home equity line of credit allows you to borrow any amount up to the limit of the credit line. Home equity loans include both principal and interest payments; most home equity lines of credit are interest-only for the first 10 years.

As with refinancing, a critical factor in considering these types of loans is your interest rate.

"If you are one of the many people who refinanced in the last three years and have a great rate, then apply for a home equity line of credit or a home equity loan," said Rainwater. "You can use it for anything - college tuition, purchase of a car, upgrades to a house, so that's available without having to touch your primary mortgage."

If you need money and only intend to keep the house for a short time, go with an equity line of credit, not an equity loan or a refinance. Both refinancing and equity loans have fees associated with them. While the equity loan fees are lower than the refinance fees, they can be avoided altogether by going with an equity line of credit.

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Home Equity Do & Don't

The FTC website (http://www.ftc.gov) provides a list of Do's and Don'ts so you can protect yourself against losing your home to inappropriate lending practices:

Don't:

Agree to a home equity loan if you don't have enough income to make the monthly payments.

Sign any document you haven't read or any document that has blank spaces to be filled in after you sign.

Let anyone pressure you into signing any document.

Agree to a loan that includes credit insurance or extra products you don't want.

Let the promise of extra cash or lower monthly payments get in the way of your good judgment about whether the cost you will pay for the loan is really worth it.

Deed your property to anyone. First consult an attorney, a knowledgeable family member, or someone else you trust.

Do:

Ask specifically if credit insurance is required as a condition of the loan. If it isn't, and a charge is included in your loan and you don't want the insurance, ask that the charge be removed from the loan documents. If you want the added security of credit insurance, shop around for the best rates.

Keep careful records of what you've paid, including billing statements and canceled checks. Challenge any charge you think is inaccurate.

Check contractors' references when it is time to have work done in your home. Get more than one estimate.

Read all items carefully. If you need an explanation of any terms or conditions, talk to someone you can trust, such as a knowledgeable family member or an attorney. Consider all the costs of financing before you agree to a loan.

Home Equity Loans Tips & Info

What is a home equity loan?
When you borrow money and put up the equity in your house as collateral, it’s called a home equity loan. These loans can be easier and larger than other loans you may be able to get, but they also put your home at risk.

What protection to I have against losing my home with a home equity loan?
The most important protection you have is to insure you get an honest lender and that you are capable of paying back the loan under the terms you agree to. Remember it is he equity in your house providing the loan, meaning the lender knows if you can't repay they can put a claim on the house.

YOU HAVE 3 DAYS TO CANCEL A HOME EQUITY LOAN

A federal credit law gives you three days to reconsider a signed credit agreement and cancel the deal without penalty. Your "right to rescind" or "right to cancel" is guaranteed by the Truth In Lending Act.

You can cancel the loan for any reason but only if you are using your principal residence as collateral, not a vacation or second home.

Use Caution When Borrrowing Against Home Equity

USA Today has a good article cautioning that you make sure your financial foundation is strong when borrowing against your Home Equity:

Many homeowners are taking advantage of the sharp rise in real estate values by borrowing against the equity in their homes. While interest rates have been creeping higher all year, the average rate on a home equity line of credit is still about 4.7%. Interest on home loans is usually tax deductible.

See the full article here.

What the HELOC?

"HELOC"

Home equity line of credit, also known as HELOC, is a simple interest loan. A Home Equity Line of Credit is a revolving line of credit, similar to a credit card. Monthly payments will vary, depending on the outstanding balance and fully indexed rate. Interest is calculated the day after principal payments are made. In most cases, interest payments are tax deductible, unlike credit cards or personal unsecured loans.

There are a variety of reasons that home owners take out a Home Equity Line of Credit. Such reasons include, debt consolidation, home improvements, education, automobile purchase, investments, vacations, business ventures, etc.

Because the borrower pays interest only on the outstanding Home Equity Line of Credit balance, a substantial savings can be realized by paying the loan off early. Also, payments to the principal immediately reduce the monthly payment, potentially SAVING THE BORROWER HUNDREDS, OR EVEN THOUSANDS OF DOLLARS.

Benefits of HELOC:
Home Equity Line of Credits have one of the lowest interest rates and minimum payments of any other consumer loan.
Application and documentation requirements are generally less than for traditional first or second mortgages, making it easier to qualify for a Home Equity Line of Credit.
Mortgage insurance is not required on any Home Equity Line of Credits, which reduces monthly payments.
Interest payments are tax deductible.
Home Equity Line of Credits may create significant monthly cash flow when the borrower uses them to pay off existing debts.
Interest payments may be tax deductible

Who is the program right for?

A Home Equity Line of Credit is beneficial over a cash-out refinance when you are able to repay the loan off before the repayment period of the loan. Because the draw period only collects interest payments, you will not see the balance of the loan decrease. But the interest rate will be lower than the mortgage interest rate.

When you have a prepayment penalty on your first mortgage you can take out a Home Equity Line of Credit for your cash-out needs instead of doing a cash-out refinance to avoid paying the prepayment penalty.

A Home Equity Line of Credit is right for a very responsible borrower. With a line of credit you need to manage your financials yourself. You are able to tap into the line of credit throughout the draw period which is beneficial to those that need available cash, but also can be a problem for those that do not have self discipline.

Overall, a Home Equity Line of Credit is recommended when there is no benefit to refinancing.

HELOC, Home Equity Loans, Home Equity Line of Credit

Shop, Compare, Negotiate

Shopping, comparing, and negotiating may save you thousands of dollars on mortgages, home equity loans and refis so always obtain information from several lenders (more good info from the FTC website.)

Home loans are available from several types of lenders—thrift institutions, commercial banks, mortgage companies, and credit unions. Different lenders may quote you different prices, so you should contact several lenders to make sure you're getting the best price. You can also get a home loan through a mortgage broker. Brokers arrange transactions rather than lending money directly; in other words, they find a lender for you. A broker's access to several lenders can mean a wider selection of loan products and terms from which you can choose. Brokers will generally contact several lenders regarding your application, but they are not obligated to find the best deal for you unless they have contracted with you to act as your agent. Consequently, you should consider contacting more than one broker, just as you should with banks or thrift institutions.

Whether you are dealing with a lender or a broker may not always be clear. Some financial institutions operate as both lenders and brokers. And most brokers' advertisements do not use the word "broker." Therefore, be sure to ask whether a broker is involved. This information is important because brokers are usually paid a fee for their services that may be separate from and in addition to the lender's origination or other fees. A broker's compensation may be in the form of "points" paid at closing or as an add-on to your interest rate, or both. You should ask each broker you work with how he or she will be compensated so that you can compare the different fees. Be prepared to negotiate with the brokers as well as the lenders.

Obtain All Important Cost Information

Be sure to get information about mortgages from several lenders or brokers. Know how much of a down payment you can afford, and find out all the costs involved in the loan. Knowing just the amount of the monthly payment or the interest rate is not enough. Ask for information about the same loan amount, loan term, and type of loan so that you can compare the information. The following information is important to get from each lender and broker:

Rates

Ask each lender and broker for a list of its current mortgage interest rates and whether the rates being quoted are the lowest for that day or week.

Ask whether the rate is fixed or adjustable. Keep in mind that when interest rates for adjustable-rate loans go up, generally so does the monthly payment.

If the rate quoted is for an adjustable-rate loan, ask how your rate and loan payment will vary, including whether your loan payment will be reduced when rates go down.

Ask about the loan's annual percentage rate (APR). The APR takes into account not only the interest rate but also points, broker fees, and certain other credit charges that you may be required to pay, expressed as a yearly rate.

Points

Points are fees paid to the lender or broker for the loan and are often linked to the interest rate; usually the more points you pay, the lower the rate.

Check your local newspaper for information about rates and points currently being offered.

Ask for points to be quoted to you as a dollar amount—rather than just as the number of points—so that you will actually know how much you will have to pay.

Fees

A home loan often involves many fees, such as loan origination or underwriting fees, broker fees, and transaction, settlement, and closing costs. Every lender or broker should be able to give you an estimate of its fees. Many of these fees are negotiable. Some fees are paid when you apply for a loan (such as application and appraisal fees), and others are paid at closing. In some cases, you can borrow the money needed to pay these fees, but doing so will increase your loan amount and total costs. "No cost" loans are sometimes available, but they usually involve higher rates.

Ask what each fee includes. Several items may be lumped into one fee.

Ask for an explanation of any fee you do not understand.

Down Payments and Private Mortgage Insurance

Some lenders require 20 percent of the home's purchase price as a down payment. However, many lenders now offer loans that require less than 20 percent down—sometimes as little as 5 percent on conventional loans. If a 20 percent down payment is not made, lenders usually require the home buyer to purchase private mortgage insurance (PMI) to protect the lender in case the home buyer fails to pay. When government-assisted programs such as FHA (Federal Housing Administration), VA (Veterans Administration), or Rural Development Services are available, the down payment requirements may be substantially smaller.

Ask about the lender's requirements for a down payment, including what you need to do to verify that funds for your down payment are available.

Ask your lender about special programs it may offer.

If PMI is required for your loan:

Ask what the total cost of the insurance will be.

Ask how much your monthly payment will be when including the PMI premium.

Ask how long you will be required to carry PMI.

Obtain the Best Deal That You Can

Once you know what each lender has to offer, negotiate for the best deal that you can. On any given day, lenders and brokers may offer different prices for the same loan terms to different consumers, even if those consumers have the same loan qualifications. The most likely reason for this difference in price is that loan officers and brokers are often allowed to keep some or all of this difference as extra compensation. Generally, the difference between the lowest available price for a loan product and any higher price that the borrower agrees to pay is an overage. When overages occur, they are built into the prices quoted to consumers. They can occur in both fixed and variable-rate loans and can be in the form of points, fees, or the interest rate. Whether quoted to you by a loan officer or a broker, the price of any loan may contain overages.

Have the lender or broker write down all the costs associated with the loan. Then ask if the lender or broker will waive or reduce one or more of its fees or agree to a lower rate or fewer points. You'll want to make sure that the lender or broker is not agreeing to lower one fee while raising another or to lower the rate while raising points. There's no harm in asking lenders or brokers if they can give better terms than the original ones they quoted or than those you have found elsewhere.

Once you are satisfied with the terms you have negotiated, you may want to obtain a written lock-in from the lender or broker. The lock-in should include the rate that you have agreed upon, the period the lock-in lasts, and the number of points to be paid. A fee may be charged for locking in the loan rate. This fee may be refundable at closing. Lock-ins can protect you from rate increases while your loan is being processed; if rates fall, however, you could end up with a less favorable rate. Should that happen, try to negotiate a compromise with the lender or broker.

Remember: Shop, Compare, Negotiate

When buying a home, remember to shop around, to compare costs and terms, and to negotiate for the best deal. Your local newspaper and the Internet are good places to start shopping for a loan. You can usually find information both on interest rates and on points for several lenders. Since rates and points can change daily, you'll want to check your newspaper often when shopping for a home loan. But the newspaper does not list the fees, so be sure to ask the lenders about them.

Don't be afraid to make lenders and brokers compete with each other for your business by letting them know that you are shopping for the best deal.

June 24, 2004 in Learning & Tips | Permalink | Comments (0)