Using Your Home as Collateral
What does it mean to use my home as collateral?
You use your home as collateral when you borrow money and “secure” the financing with the value of your home. This means if you don’t repay the financing, the lender can take your home as payment for your debt.
Refinancing your home, getting a second mortgage, taking out a home equity loan, or getting a HELOC are common ways people use a home as collateral for home equity financing. But if you can’t repay the financing, you could lose your home and any equity you’ve built up. Your equity is the difference between what you owe on your mortgage and how much money you could get for your home if you sold it. High interest rates, financing fees, and other closing costs and credit costs can also make it very expensive to borrow money, even if you use your home as collateral.
How can I reduce the risks of borrowing against my home?
Consider your options and your budget. Keep in mind the risks involved when using your home as collateral. If you can’t pay the money back, you could lose your home to foreclosure. Talk to an attorney, financial advisor, or someone else you trust before you make any decisions. Some dishonest lenders target older adults, homeowners with modest means, and borrowers with credit problems. They offer financing based on the equity in your home, not on your ability to repay the balance due. If you fall behind on the payments, the lender can try to declare your financing in default and serve you with a notice of default. Usually that’s the first step in the foreclosure process.
What are the warning signs of a dishonest lender?
Dishonest lenders may contact you with a supposed deal on financing. They may say your credit history doesn’t matter. They will try to push you into more expensive agreements with less favorable terms and pressure you to commit before you’ve had a chance to research and consider other options. Know that legitimate lenders will give you time to review the terms of the offer in writing and want you to understand them. They will never ask you to sign blank documents or hide disclosures and key terms.
Here are some rules of thumb to spot and avoid dishonest lenders:
- Avoid a lender who wants you to apply to borrow more than the amount you need.
- Don’t deal with a lender who wants you to get financing with monthly payments bigger than you can comfortably make.
- Never work with a lender who wants you to lie on a financing application — like saying your income is higher than it really is.
- Avoid lenders who say to sign blank forms. If they fill in the blanks later, you don’t know what they’ll say.
- Never work with a lender who says you can’t have copies of the documents you signed. Of course you can.
- Don’t deal with any lender who tells you not to read the financing disclosures. The law says you must get them, so make sure you do — and be sure to read and understand them before you sign for the financing.
- And be sure to avoid any lender who promises one deal when you apply, but gives you a different set of terms to sign, with no good explanation of the change.
Home Equity Loans
What is a home equity loan?
A home equity loan — sometimes called a second mortgage — is a loan that’s secured by your home. You get the loan for a specific amount of money and it must be repaid over a set period of time. You typically repay the loan with equal monthly payments over a fixed term. If you don’t repay the loan as agreed, your lender can foreclose on your home.
The amount that you can borrow — and the interest rate you’ll pay to borrow the money — depend on your income, credit history, and the market value of your home. Many lenders prefer that you borrow no more than 80 percent of the equity in your home.
How do I shop for a home equity loan?
Consider contacting your current lender to see what they offer you as a home equity loan. They may be willing to give you a deal on the interest rate or fees. Ask friends and family for recommendations of lenders. Then do some research into the lenders’ offerings and prepare to negotiate a deal that works best for you. Use the Shopping for a Home Equity Loan Worksheet.
- Ask each lender to explain the loan plans available to you. Read Shopping for a Mortgage FAQs for tips on talking to lenders and brokers — and how to compare the terms of their offers. If you don’t understand loan terms and conditions, ask questions. They could mean higher costs. Some important factors to learn more about include:
- APR: The Annual Percentage Rate (APR) is the single most important thing to compare when you shop for a home equity loan. The APR is the total cost you pay for credit, as a yearly rate. Generally, the lower the APR, the lower the cost of your loan. APR includes the interest rate, but also includes points, broker fees, and other charges as a yearly rate. Each point is a fee equal to one percent of the loan amount. Knowing the APR makes it easier to compare “apples to apples” when considering offers.
- Balloon payments: This is a payment, usually due at the end of the loan, that’s often much larger than your usual monthly payment. Balloon payments are common for interest-only loans where your monthly payments go to pay interest and do not pay down any of the principal. Find out if your loan terms say you’ll owe a balloon payment. If you can't pay it when the time comes, you may need to get and pay for another loan, which means going through the mortgage process again and paying new closing costs, points, and fees.
- Prepayment penalty: Some loan contracts include a penalty if you pay off your loan earlier than expected, or if you refinance. If the penalty is high enough, you might have to keep a loan with a high interest rate because it would be too expensive to get out of it.
- Credit insurance: If you get sick, become disabled, or die, credit insurance will make your loan payments, if you buy it. But, if you currently have life or disability insurance, you already may have similar protection. Lenders must tell you if credit insurance is required for your loan; otherwise, it cannot be included in your loan unless it is voluntary, you receive a statement about the costs of the credit insurance, and you sign to buy it. If you don’t want credit insurance, do not sign for it; if it is already included in the loan when presented to you for signature, tell them to remove that fee.
- Ask for your credit score. Credit scoring is a system creditors use to help decide whether to give you credit. Information like your bill-paying history, the number and type of accounts you have, late payments, collection actions, outstanding debt, and how long you've had your accounts helps predict how likely it is that you’ll repay the loan — and on time.
- Negotiate with more than one lender. Don’t be afraid to make lenders and brokers compete for your business by letting them know that you’re shopping for the best deal. Ask each lender to lower the points, fees, or interest rate. And ask each to meet — or beat — the terms of the other lenders.
- Before you sign, read the loan closing papers carefully. If the loan isn’t what you expected or wanted, don’t sign. Either negotiate changes or walk away. You also generally have the right to cancel a home equity loan on your principal residence for any reason — and without penalty — within three days after signing the loan papers. For more information, see The Three-Day Cancellation Rule.
- Don’t wire money in response to unexpected emails. You could get an email, supposedly from your loan officer or other real estate professional that says there’s been a last-minute change. They might ask you to wire the money to cover your closing costs to a different account. Don’t do it — it’s a scam. If you get an email like this, contact your lender, broker, or your real estate professional at a number or email address that you know is real and tell them. Scammers often ask you to pay in ways that make it tough to get your money back. No matter how you paid a scammer, the sooner you act, the better. Learn more about how to get your money back.
The Three-Day Cancellation Rule
What is the Three-Day Cancellation Rule?
This federal rule says you have three business days, including Saturdays but NOT Sundays, to reconsider a signed credit agreement that secures your principal residence and cancel the deal without penalty. The Three-Day Cancellation Rule applies to many home equity loans (and also applies to home equity lines of credit, see below).
You can cancel for any reason, but only if you’re using your main residence as collateral. That could be a house, condominium, mobile home, or houseboat. The right to cancel doesn’t apply to a vacation or second home.
Under the Rule, how long do I have to cancel?
You have until midnight of the third business day to cancel your loan. Day one begins after all these things have happened
- you sign the loan at closing, and
- you get a Truth in Lending disclosure form with key information about the credit contract, including the APR, finance charge, amount financed, and payment schedule, and
- you get two copies of a Truth in Lending notice explaining your right to cancel
If you didn’t get the disclosure form or the two copies of the notice — or if the disclosure or notice was incorrect — you may have up to three years to cancel.
How do I determine the third business day?
You may get the disclosure and two copies of the right to cancel notice at your closing. In that case, Day One begins after the closing. But if you get the disclosure form and the two copies of the notice before or after the closing, Day One begins on when the last of the three things happened. So if the closing happens on a Friday, and if that was the last thing to happen, you have until midnight on Tuesday to cancel. But if you received your Truth in Lending disclosure form on Thursday and you closed on Friday, but didn’t receive two copies of the right to cancel notice until Saturday, you have until midnight on Wednesday to cancel. For cancellation purposes, business days include Saturdays but not Sundays or legal public holidays.
During this three-day waiting period, the lender cannot directly or through another person take action related to the loan. The lender can’t deliver the money for the loan (other than in escrow), or begin performing services. If you’re getting a home improvement loan, the contractor can’t deliver any materials or start work. The lender can begin to accrue finance charges during the delay period.
What steps do I take if I want to cancel?
You must inform the lender in writing that you want to cancel:
- You must mail or deliver your written notice before midnight of the third business day.
- You may not cancel by phone or in a face-to-face conversation with the lender.
Will I owe any money on the contract if I cancel during the three-day waiting period?
If you cancel the contract, the security interest on your home is no longer valid, your home is no longer collateral and can’t be used to pay the lender. You don’t have to pay anything, and any amounts you paid must be refunded, including the finance charge and other charges, such as application fees, appraisal fees or title search fees, whether paid to the lender or to another company that is part of the credit transaction. The lender has 20 days after receiving your notice to return all money or property you paid as part of the transaction and to release their interest in your home as collateral, which they must do even though the security interest is no longer valid from the day the lender received your cancellation notice.
If you got money or property from the lender, you can keep it until the lender shows that your home is no longer being used as collateral and returns any money you’ve paid. Then, you must offer to return the lender’s money or property. If the lender doesn’t claim the money or property within 20 days, you can keep it.
Under the Rule, can I waive my right to cancel the contract?
If you have a personal financial emergency — like damage to your home from a storm or other natural disaster — you can waive your right to cancel. That eliminates the three-day waiting period so you can get the money sooner. To waive your right:
- You must give the lender a written statement describing the emergency and stating that you are waiving your right to cancel.
- The statement must be dated and signed by you and anyone else who also owns the home.
Your right to cancel gives you extra time to think about putting your home up as collateral for the financing to help you avoid losing your home to foreclosure. If you have a personal financial emergency, you can waive this right, but be sure that’s what you want before you waive it.
Are there exceptions to the Three Day Cancellation Rule?
Yes, the federal rule doesn’t apply in all situations when you are using your home for collateral. Exceptions include when
- you apply for a loan to buy or to initially build your main residence
- you refinance your mortgage with the same lender who holds your loan and you don’t borrow more funds (but if you borrowed additional money the rule applies and you can cancel)
- a state agency is the lender for a loan
In these situations, you may have other cancellation rights under state or local law.
Home Equity Line of Credit (HELOC)
What’s a home equity line of credit?
This type of financing, also known as a HELOC, is a revolving line of credit, much like a credit card except it is secured by your home. The lender approves you for a certain amount of credit. Generally, as long as you stay under that credit limit, you can borrow as much as you need, any time you need it, by writing a check or using a credit card connected to the account. Many HELOCs have an initial period of time — a draw period — when you can borrow from the account. After that, you might be able to renew the credit line but if not, you will probably have to start repaying the amount due — either the entire outstanding balance or through payments over time. HELOCs generally have variable interest rates and payments so the rates and payments can go up or down over time.
Like home equity loans, you use your home as collateral for a HELOC. This can put your home at risk if you can’t make your payments or they’re late. And, if you sell your home, most HELOCs make you pay off your credit line at the same time.
How do I pay back a HELOC?
Because a HELOC is a line of credit, you make payments only on the amount you actually borrow, not the full amount available. A HELOC also may give you certain tax advantages unavailable with other kinds of loans. Talk to an accountant or tax adviser for details.
How much money can I borrow on a home equity line of credit?
It depends on several things, including your creditworthiness That means your history of regularly repaying money and the amount of debt you owe now.
Comparing home equity loans and home equity lines of credit
Home Equity Loan
What is it?
a fixed amount of money you borrow for a fixed amount of time, secured by your home
you typically get all of the money in advance
a revolving line of credit, secured by your home, that generally you can draw on as needed (like a credit card)
includes points, fees, and other charges
based on interest alone —doesn’t include points and other financing charges
often is fixed
usually is variable
What amount do you pay interest on?
on the entire loan amount (interest is usually included in your monthly payment)
only on the money you use, not the entire amount you can access
Safeguards and Protections for HELOCs
What federal safeguards apply to HELOCs?
Under federal law, lenders must tell you:
- about the terms and costs of the line of credit in most cases when you get an application
- the APR and payment terms
- the charges by the creditor to open, use, or maintain the account, like an application fee, annual fee, or transaction fee
- the charges by other companies to open the line of credit, like an appraisal fee, fee to get a credit report, or attorneys’ fees
- about any variable-rate feature
Lenders must give you a brochure describing the general features of HELOCS.
If you decide not to take the HELOC because of a change in terms from what you expected, the lender must return all of the fees you paid.
Lenders also must give you three business days, including Saturdays, but not Sundays, to cancel a HELOC, which usually starts to run from when you opened the plan, or when you received all material disclosures, whichever occurs last:
- You may cancel the HELOC for any reason.
- To cancel, you must inform the lender in writing within the three-day period. Then the lender must cancel its security interest in your home and must also return fees you paid to open the plan.
- If the required notice and disclosures are not provided, you may have up to three years after opening the plan to rescind the HELOC.
- For more information, see The Three-Day Cancellation Rule.
Generally, once your home equity plan is opened, if you pay as agreed, the lender may not end your plan, demand that you speed up payment of your outstanding balance, or change the terms of your account:
- The lender may stop credit advances on your account during any period in which interest rates exceed the maximum rate stated in your agreement, depending on what your contract says.
- The lender also may freeze or reduce your line of credit if the value of the home declines significantly below the appraised amount, or the lender reasonably believes you will be unable to make your payments due to a material change in your financial circumstances. If this happens, you could talk with your lender and try to restore your line of credit, or shop around for another mortgage to pay off your prior line of credit and get another one.
How can I avoid possible pitfalls with a HELOC?
Before you sign, read the closing papers. If the HELOC isn’t what you expected or wanted, don’t sign the financing. Either negotiate changes or walk away.
High-Cost and Higher-Priced Mortgages
What special protections are available for high-cost mortgages and higher-priced mortgages?
A high-cost mortgage is a mortgage used to buy a home, a home equity loan (or second mortgage or refinance), or a HELOC that is: secured by your principal residence; and the APR (or points and fees charged) exceed certain threshold amounts that are tied to market conditions. If you have a high-cost mortgage, you may have additional rights under federal law, the Home Ownership and Equity Protection Act (HOEPA) and the CFPB has more information about your special rights.
If instead you have a higher-priced mortgage with an APR higher than a benchmark rate called the average prime offer rate (the interest rate charged to borrowers that have the best credit), you may have additional rights. You may be entitled to these rights if your higher-priced mortgage is used to buy a home, for a home equity loan, second mortgage, or a refinance secured by your principal residence. These additional protections do not apply to HELOCs. If you have a higher-priced mortgage, the CFPB has additional information about your rights.
Lending and Mortgage Servicing Practices That Can Hurt You
You could lose your home and your money if you borrow from dishonest lenders. Certain lenders target homeowners who are older or who have moderate means or credit problems — and then try to take advantage of them by using deceptive, unfair, or other unlawful practices like these:
- Loan flipping happens when the lender encourages you to repeatedly refinance the loan, which often leads you to borrow more money. Each time you refinance, you pay additional fees and interest points. That increases your debt.
- Insurance packing happens when the lender adds to your financing credit insurance or other insurance products that you may not need.
- Bait-and-switch happens when the lender offers one set of terms when you apply, then pressures you to accept higher charges when you sign to complete the deal.
- Equity stripping which involves practices that reduce the value in your home, can happen when the lender offers financing based on the equity in your home, not on your ability to repay. If you can’t make the payments, you could end up losing your home.
- Non-traditional products include home equity loans that
- have monthly payments that increase — either because they have variable interest rates, or because the minimum payment doesn’t cover the principal and interest due
- have low monthly payments, but a large lump-sum balloon payment due at the end of the loan term. If you can’t make the balloon payment or refinance, you face foreclosure and the loss of your home.
You may encounter harmful practices related to the day-to-day management (called servicing) of your mortgage payments. There are several types of servicing abuses, including a lender charging you improper fees or not giving you accurate or complete account statements and payoff figures. Learn more about your rights when making your mortgage payments.
Some of these harmful home equity practices violate federal credit laws dealing with disclosures about financing terms, debt collection, and discrimination based on age, gender, marital status, race, or national origin. You also may have additional rights under state law that would let you bring a lawsuit.
If you think your lender has violated the law, you may want to contact the lender or servicer to let them know. At the same time, you also may want to contact an attorney.
You also can report fraud to
- your state attorney general
- your state banking regulatory agency
- the Federal Trade Commission at ftc.gov
- the Consumer Financial Protection Bureau