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. (While mostly no longer
available, we mention these types of loans because history has a way of
repeating itself and we may once again see these loans emerge.)
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. While the above represent some reasonable
decisions, in this world of less flexible lending environment lenders are
reluctant to accept any form of secondary financing at home purchase time. We
recognize that there are many good reasons for current home owners to use
secondary financing . . . to make home improvements, to finance education, etc.
Equity loan financing is likely to be the selected form of said financing which
is typically limited to a maximum Loan-to-Value (LTV) of 80%. The loss of home
values will impede many homeowners from acquiring any form of secondary
financing.
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.
Webpage/equity financing