Is this increase in lending percentages new or is it cyclical?
It's been going on for the last decade, at least. Success requires a very strong economy and a belief that home prices will continue to increase dramatically. I don't see that happening anytime soon.
Is high-percentage borrowing dangerous?
“Make sure you know what the interest is today and what it might be a year or two from now.”
I have argued that it's dangerous for many borrowers because, in effect, you're borrowing against your home. That has two dramatic disadvantages for the typical borrower. One is if you default on your mortgage loan or home equity line or loan, you may lose your home. The second concern I have is that for U.S. investors, the home is typically the biggest investment that they have. And if they borrow against it, what are they going to retire on? It could potentially cut into their retirement sources of finance.
The other thing I have observed, watching home equity since 1986, is that the margin and fees that lenders charge has decreased. The margins have become much more competitive. Consumers are borrowing, trying to live to their heart's extent. So, we have both a willing supplier and willing borrower/demander.
- Which fees in particular should borrowers look out for?
Watch out for all fees. The Federal Reserve and the Federal Trade Commission have excellent guides for potential home equity borrowers.
- Which are the most egregious?
Arrangement and application fees are often resented by the borrower. I urge borrowers to carefully check and understand all fees as they apply for a home equity loan and at closing. Don't sign the application or the closing documents if you are uncomfortable with the fees. Borrowers should understand they are in the driver's seat when applying for a loan at a particular lender. They can always try to get a better deal at another lender.
- Which get people into the most trouble?
Prepayment fees, which are often a tradeoff for lower interest rates, are a problem for borrowers if they are able to pay off the second mortgage early because of a good fortune or because they sell the house. Transaction fees can also be a problem for borrowers that make frequent draws on their home equity lines of credit.
- Are any negotiable?
All fees are negotiable. Stamp or recording fees have to be paid by someone (borrower or lender), but the others can often be negotiated away.
Despite admonitions about the importance of reading and understanding all contracts before signing, it seems that many Americans know very little about the terms of their home equity borrowing. What tips would you give for reading contracts?
The major caution for individuals is make sure you understand the loan, that you understand what the interest percentage is and what it might be a year to three years from now. A lot of borrowers are saying they didn't realize the interest rate was a teaser rate and would go up later, even though it was clearly stated in the contract. Make sure you know what the interest is today and might be a year or two from now. Many people don't.
Read the contract. As your mother said, 'Don't believe everything you hear,' and that really is true with a loan transaction. She also probably told you not to believe everything you read, but at least if it's written, you have some legal standing to say 'but that's not what they told me.' I guess the first caution is to read it, but if you're saying you really don't want to read it, then read the interest rate today and the maximum interest rate of that loan and if you don't understand it, ask to have it explained. Then read through all fees. Understand what the fees are and what you're really borrowing. Crunch the numbers with the Bankrate amortization calculator.