Problems with Home Equity Lines of Credit

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A home equity line of credit (HELOC) is a loan using the equity in your home. Your home is pledged as collateral for the loan. Home equity lines of credit come with a number of problems. A HELOC is based on the amount of equity in your home, which is the difference between the market value and the balance owed. A home equity line of credit will have different terms and agreements based on the lender.

Equity

The value of your property can decline, which makes it difficult to sell your property. When the economy is in a recession, property values can decline, possibly wiping out your equity. When it is time to sell the home there may not be enough equity to pay off the first mortgage or the home equity line of credit. Without sufficient equity you may not be able to borrow against your home.

Variable Rate

Home equity lines of credit have variable rates, which are tied to certain indexes plus a margin. If the index increases, the rate on the HELOC can increase and in turn the payment will increase. Sometimes payments can increase beyond a consumer’s ability to make the payments. Late payments can lead to delinquency. It is difficult to budget when your payments are going up and down.

Foreclose

If a debtor cannot make her payments, the lender can foreclose on the property. When a home is foreclosed on it will be sold at a sheriff’s sale and there could be a balance, which the debtor will still owe, depending on the state. This balance is called a deficiency balance.

Taxes

The debtor may not owe money after a foreclosure even though the sheriff’s sale did not pay off the entire balance owed. Lenders will sometimes forgive the debt. When debt is forgiven the debtor may have to file it on his taxes as taxable income. A lender will mail a 1099-C form, which is a debt cancellation form, after the debt is forgiven. Never ignore these forms. Contact your tax professional or a real estate attorney to see if you have a tax obligation.

Fees

If you pay off your HELOC and you don’t close it out, you could be assessed an annual fee. Some accounts have early closeout fees, which are in effect for the first three or five years. If you want to close out an account during that time frame to avoid an annual fee, you will still be subject to the early closeout fee. If you leave the account open you will have to pay the annual fee. It’s a catch-22.

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