Question: I was wondering: If you have a home equity loan and you want to sell your house, are you pretty much stuck in your home until the loan is paid off?
Or, when you sell your home, do you just have to make sure you get enough money out of the home sale to pay the home equity loan off?
Unfortunately, we were not clear on this when we took out our home equity loan.
Answer: This is a very good question, especially since most homeowners in the Puget Sound region have seen the value of their homes drop by 10 percent to 30 percent since the housing market peaked in 2007.
Home equity loans and home equity lines of credit should be used very carefully. Remember, you’re talking about putting a second mortgage on your home. In the old days, taking out a second mortgage was considered a last resort, an act of financial desperation. But in the last few years, people casually used home equity loans to buy cars, pay off credit cards, take vacations and a variety of other somewhat questionable financial purposes.
One reason for the rush to home equity loans is the 1986 Tax Reform Act, which eliminated the tax deduction for interest on credit cards, car loans and most other consumer borrowing. The interest expense on home equity loans is one of the few remaining tax shelters left, so many people now use tax-deductible home equity loans to purchase cars rather than nondeductible auto loans. If you can handle the monthly payments, there’s nothing inherently wrong with that.
But as your letter points out, the home equity loan creates a lien on your property that must be paid off when you sell your home. As long as you have plenty of equity in your home (the difference between the home’s value and the total amount of loans against it) that’s not a problem.
But if you don’t net enough cash from the sale of your home to pay off your first and second mortgage (home equity loan), plus all the home-selling expenses, you are going to be in trouble because you would literally have to bring cash to the closing table in order to sell your home.
This is a common problem today because many people took out large home equity loans during 2006 and 2007 when home values were at their peak and homeowners had lots of equity. Now that home prices have fallen, many homeowners are upside down, which means they owe more money on the combined balances of their first and second mortgages (home equity loan) than their home is currently worth.
So if you are in that situation, and the total of your first and second mortgage is more than the value of your home, you are stuck until you either pay down the balance of your home equity loan until you have enough equity to sell your home or wait for home prices to appreciate to the point where you have enough equity to pay off the first and second mortgages when you sell your home.
The good news is that if you have a home equity line of credit with an interest rate tied to the prime rate, that rate is only 3.25 percent right now, so you can pay down your home equity loan much faster today than you could when the prime rate was 8.25 in 2007. So if you plan to stay in your home for the long term (10 years or more) it makes sense to pay down the home equity loan as soon as you can while rates are low. If you plan to sell your home in the next few years, you may also want to pay down your loan balance, but it may make more sense to pay the minimum and hope you can pay off the balance when you sell.
If you are counting on home price appreciation to bail you out, I think you will have a very long wait. I have predicted that we won’t see any significant home price appreciation in this area for several more years. In fact, home prices may continue to fall as the “shadow inventory” of bank-owned homes come on the market.
Real estate prices are largely driven by supply and demand. Right now, there are more home sellers than buyers. and if the banks start dumping a lot more houses onto the market that will increase supply and further depress housing prices because there is not likely to be an increase in home buyer demand in the near future.
The only other way to get out of your situation would be to do a short sale which means that you must get the bank holding your home equity loan to agree to take less money at closing if you sell your home. However, if you have money in the bank or other assets, the bank is likely to make you sign a promissory note to pay the difference after the home is sold, so you won’t get off free.
I know this is probably not what you want to hear, but this is the reality faced by many homeowners in the Puget Sound region today.
Mail your real estate questions to Steve Tytler, The Herald, P.O. Box, Everett, WA 98206, or e-mail him at economy@heraldnet.com.
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