Home Equity Loan - The Don'ts
'No' to a balloon payment.
Any money that has been borrowed from a home equity loan or a home
equity line of credit and remains unpaid at the end of the loan
term is a called a balloon payment. This balloon payment is a large
lump sum of money that is due when a home equity loan expires. A
balloon payment is a risky situation and should be avoided.
Both home equity lines of credit and home equity loans can result
in balloon payments.
You take out a home equity line of credit and withdraw your limit
of $20,000. You make only interest payments for the life of the
line of credit and then you are forced to come up with $20,000.
In a home equity loan, your lender may offer you a lower interest
rate if you agree to a balloon payment at the end of the loan term.
The lender can offer this lower rate because the interest paid on
the large unpaid balloon balance will recover many dollars for the
lender. The lender also benefits because without the lower interest
rate bringing down your monthly payments, you could not afford to
take out the loan. The lower monthly payments make the loan affordable
to you - you have easy, manageable payments but at the end of the
loan term you are faced with coming up with a large sum of money.
A lump sum balloon payment can only be paid by coming up with a
large sum of money, refinancing the balloon amount or taking out
another loan, or by selling your home.
Lets review these options.
If you are taking out a home equity loan this means you need cash.
In most situations, it is very unlikely that a few years down the
road you will somehow 'come up with' many thousands of dollars to
pay off your balloon payment.
Refinancing your home equity loan or taking out another loan is
both risky and expensive. You cannot predict what the interest rate
will be for your new loan since it is many years in the future.
Refinancing the balloon payment means you will paying interest on
the balloon amount over the life of two loans and you may be charged
Being forced to sell your home at some point in the future is very
risky as you do not know what your house will be worth. If the housing
market shifts against your favor and your home falls in value but
you are forced to sell, you could lose thousands on your home and
you may not even have enough money from the sale to make your balloon
If you need a balloon payment, this may be a sign that you cannot
afford the home equity loan. Ask your lender if the loan you are
being offered has a balloon payment or if it can create one. A balloon
payment is a risky option that should be avoided.