Home Equity Loan Don'ts
a high LTV loan
If a home is worth $100,000 and it has a $70,000 first mortgage
and a $30,000 home equity loan, the loan-to-value ratio is 100%.
This means that for every dollar that the home is worth, one dollar
is borrowed against it.
Lenders have typically allowed home equity loans of 80% but now
lenders go as high as LTV's of 125%. A high LTV loan is a loan with
an LTV of 100% or more. High LTV loans should be avoided because
they are expensive, risky and you lose tax advantages.
When your 'home equity loan' raises your LTV above 100%, this is
no longer a home equity loan. A home equity loan is a loan which
is secured by your home - when you go above an LTV of 100%, your
home is not worth enough to secure the amount you want to borrow.
The unsecured part of your loan poses a great degree of risk to
the lender and they pass this risk on to you in the form of a much
more expensive loan.
A high LTV loan also directly poses risk to you. Going back to
the $100,000 home with a $70,000 mortgage. Say that instead the
home equity loan is for $50,000 - this raises the total borrowed
amount to $120,000 giving an LTV of 120%. If the home is sold, the
proceeds from the sale will be $100,000 and minus costly real estate
fees - that does not cover the $120,000 that is owed.
When you exceed 100% LTV, the portion of your home equity loan
in excess of your home's value is not tax deductible with a few
exceptions. Take the example of the $100,000 home with a $70,000
mortgage and a $50,000 home equity loan. Only the interest paid
on the first $30,000 of your home equity loan is tax-deductible
and interest on the $20,000 above the $100,000 price of the home
is not. Exceptions that would allow for the full home equity loan
amount to be tax deductible are if the home equity loan was used
for home improvement or to buy another home.
Here is another example of how an increasing LTV increases the
overall risk and costs you money. If you decide on cash-out refinancing
to access home equity and you go above an 80% LTV, your lender will
require you to pay for private mortgage insurance that protects
the lender if you default on your loan.
Don't exceed your home's value when borrowing against it - it is
expensive and risky.