EQUITY FINANCING . . . SECONDARY
LOANS
While home values were escalating, often at double digit levels, homeowners
borrowed their equity for all kinds of reasons. Many homeowners were bombarded
via the mail encouraging them to borrow. And many did, some several times as
their property value increased. While there are very good reasons for acquiring
secondary financing (which we will discuss a bit later), many of the offers
made via the mail or by tele-marketers represented
dangerous situations. In many cases, loans were made up to 100% of the home’s
value. As home values stabilized and, in some cases, declined, homeowners found
themselves “upside down” meaning that they owed more than the home
was now worth.
Many of those past "sales pitches" were being "sold" as
a solution to debt consolidation. The "pitch" was that the second TD was
a lesser interest rate than their current credit card or installment debt and and the secondary loan would result in a reduction in
monthly payments. It was a seductive offer. But, in retrospect, borrowers may
have made some bad decisions. Credit debt, while sometimes overwhelming, if
unpaid will not result in a foreclosure. On the other hand,
if there is a default on a loan secured by the property (as in secondary
financing), the borrower could lose their home via foreclosure. Thus,
this form of secondary financing should not be encouraged, except under very
specific purposes and then, only after careful loan counseling.
Those enticing solicitations typically indicated that "you have been
approved for a loan up to $25,000" or more. The fine print usually contained
a disclaimer that the offer is "subject to the approval of a loan
application and accompanying information". Remember, if the offer sounds
"too good to be true" . . . it usually is!
BORROW UP TO $25,000 to be used for home renovation or any other purpose (buy a car, take a vacation, etc.). In the past, most of
these offers were for an FHA Title One loan or one of the "look
alike" loans. While FHA loans are used only for home repairs, the
"look alikes" did allow the funds to be
used for any purpose. A borrower had to still qualify for the loan, in spite of
the assertions to the contrary. The interest rate in most cases was fairly
high, often ranging between 7 and 11 percent and there were costs for acquiring
the loan, usually a minimum of two or three points and often higher. These
loans have become less popular as more stringent regulations have been placed
upon the lenders offering such financing. But a lot of homeowners did acquire
these loans and are now facing some difficulty.
It is important that all aspects of such financing be reviewed and
understood. We do not generally encourage secondary financing except for very
specific purposes. More recently, secondary financing ahs become very difficult
if not impossible to acquire. The UP TO 100% EQUITY LINE LOANS
are no longer available. While
very seductive when being offered, the result has been properties that are now
over-encumbered. As indicated earlier, secondary financing can play a important role in some real estate transactions. One of the
more frequent uses of a second trust deed is to reduce the Loan-to-Value of a
purchase to 80% or less in an effort to avoid a mortgage insurance payment. For
instance . . . the buyer's $25,000 cash available is insufficient for the 20%
down payment necessary to avoid Private Mortgage Insurance (PMI) on his
$150,000 purchase. A solution might be to ask the seller to carry back a second
trust deed for the $5000 difference to get to the 80% LTV (Loan-to-Value),
thereby eliminating the PMI payment of approximately $65 a month.
Let's look at another typical use of a second TD. A potential buyer has a
home to sell, from which he will realize $25,000 of net equity. While he has
sufficient cash to purchase now, he wants to acquire a new fixed rate mortgage
on the new purchase, and wants to pay down his new mortgage after he finally
sells. If the seller is willing to carry a $25,000 second TD for a short term,
the buyer can pay it off upon the sale of his property
and have only the desired first trust deed encumbering the home.
The above scenarios represent a couple of excellent uses of secondary
financing in the purchase of homes. There are also good reasons for current
home owners to use secondary financing (either in the form of an equity line
loan or a second trust deed) . . . to make home improvements, to finance
education, etc. Equity financing is more typically limited to a maximum
Loan-to-Value (LTV) of 80%.
With credit scoring so important with this type of financing, a borrower is
encouraged to identify their FICO score(s) before entertaining the notion of
acquiring secondary financing. While secondary financing can be critical in
some situations, consumers must be careful that they are not persuaded to
encumber their homes without clearly considering the full consequences of doing
so. Some of the offers for secondary financing are "too good to be
true" . . . and they are. Be very cautious and seek good counsel. Call us
at Humboldt Home Loans and we will discuss all of your loan options, including
secondary financing.
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