Home equity loans can be an affordable way to tap the equity in your house to use for home improvements, pay for education and pay off credit cards or other types of debt. They are considered second mortgages because they are secured by your property and typically have lower interest rates than non-secured loans. Formerly, the interest paid on these loans, used for personal items, was tax deductible. However, with the advent of the Tax Cuts and Jobs Act, the interest will only be deductible if the loans “are used to buy, build or substantially improve the the taxpayer’s home that secures the loan,” as stated by the Internal Revenue Service.
Two Loan Types: Home Equity Loans & HELOCs
There are two types of home equity loans. The first is a loan of a set amount of money financed for a set period (usually five to 15 years) at a fixed interest rate and with a fixed payment. The second type is called a home equity line of credit (HELOC).
A HELOC has a variable interest rate and functions more like a credit card with an expiration date (often up to 10 years after the line of credit is taken out). You can run into trouble with either type of home equity debt if you have serious financial problems, lose your job or experience an unexpected illness.
A further complication of a HELOC is the stark contrast between the initial phase ("draw" period), when you have access to the line of credit and may have to pay only interest on the money you borrow, and the second (much more costly) "repayment" phase, when the line of credit expires and you must begin repaying both principal and interest on your remaining balance. (For more clarification, read Home Equity vs. HELOC)
Lenders Won’t Automatically Foreclose
Defaulting on a home equity loan or line of credit could result in a foreclosure. What the home equity lender actually does depends on the value of your home. If you have equity in your home, your lender will likely initiate foreclosure, because it has a decent chance of recovering some of its money after the first mortgage is paid off. The more equity, the more likely your second mortgage lender will choose to foreclose.
If you are underwater (your home is worth less than the combined amount owned on both the first and second mortgages), your home equity lender may be less likely to foreclose. That’s because the first mortgage has priority, meaning that it's likely that the second mortgage holder will not receive any money after a foreclosure. Instead, the second mortgage holder will choose to sue you personally for the money you owe. While a lawsuit may seem less scary than foreclosure proceedings, it can still hurt your credit, and lenders can garnish wages, try to repossess other property or levy your bank accounts to get what is owed.
Don’t Wait to Act
Most mortgage lenders and banks don’t want you to default on your home equity loan or line of credit, so they will work with you if you are struggling to make payments. Should that happen, it's important to contact your lender as soon as possible. The last thing you should do is try to duck the problem. Lenders may not be so willing to work with you if you have ignored their calls and letters offering help.
When it comes to what the lender can do, there are a few options. Some lenders offer to modify your loan or line of credit. Bank of America, for example, will work with borrowers by offering to modify the terms, interest rate, monthly payments or some combination of the three to make the loan or HELOC more affordable. To qualify for Bank of America’s loan or HELOC modification, borrowers must meet certain qualifications:
- They must have had the loan for at least nine months.
- They must not have received any kind of home equity assistance in the last 12 months or twice in the last five years.
- They must be undergoing financial hardship.
- They must be able to repay the loan.
Other private lenders – such as Sallie Mae, which offers student loans – work with a borrower who is struggling to meet payments by offering multiple deferments and forbearance options. For borrowers who don’t qualify, Bank of America offers payment extensions or repayment plans to catch up on delinquent payments.Con
Limited Government Help
Help from the federal government is limited. The Obama administration's Home Affordable Modification Program (HAMP), which allowed eligible homeowners to reduce monthly payments, including those for second mortgages such as home equity loans and lines of credit, was closed to new applicants Dec. 30, 2016. The Making Home Affordable Mortgage Assistance Options page, however, has information and advice on seeking help from your lender, depending on whether your problem is temporary or long term.
If you live in one of the 18 states plus the District of Columbia that participates in the Hardest Hit Fund, you might be able to qualify for assistance there. Some states have already concluded their application process, and no applications will be accepted in any state after Dec. 31, 2020.
The Bottom Line
Home equity loans and lines of credit can be an inexpensive way to tap the equity in your home. If you find yourself in trouble, you do have options. From lender workouts such as a loan modification to limited government help, there are ways to get out from under a home equity or HELOC problem without going into foreclosure. The key in all options is to get help right away instead of hoping the problem will disappear on its own.
Home-Equity Loans and HELOCs
The Smartest Way to Tap Your Home Equity
Refinancing Your Home Equity Loan: A How-to Guide
5 Reasons Not to Use Your Home Equity Line of Credit
How a HELOC Fixed-Rate Option Works
Refinancing vs. Home Equity Loan
Choosing a Home Equity Loan or Line of Credit
Home Equity Line of Credit: 4 Ways to Refinance
Is Interest on a Home Equity Line of Credit (HELOC) Tax Deductible?
Bad Credit? You Can Still Get a Home Equity Loan
Mortgage vs. Home Equity Loan: How They Differ