Equity Mortgage - Risks of a no equity loan

Risks of a no equity loan

by Darryl Brooks

In researching home mortgages, you may have run across the phrase, no equity mortgage. A no equity home loan is a type of second mortgage rather than a first or initial home mortgage. It is simply a loan where some or all of the principal is unsecured by the equity of the borrower's home. The total value of the loan may be as much as twenty-five percent higher than the actual value of the property. Obviously, this is a very risky proposition for both the lender and the borrower, and should be entered into only after careful evaluation, and knowing all the facts. Recent events have clearly shown the risks involved with home loans that fall outside the norm.

In the past, many home owners have borrowed money against there houses to take advantage of low interest rates and tax savings. They can use this money to remodel or otherwise increase the value of their home. Other borrowers simply use this money to pay down other high interest loans and debt. If managed properly, either of these scenarios can make sense. But unfortunately, the no equity home loan, just like title loans on cars, have become ways for people who are already in financial trouble to increase their risk and get deeper in the hole.

As with any unsecured loan, the no equity home loan typically comes with a very high interest rate as much as 6% higher than conventional loans. In addition, the closing points and fees associated with these types of loans are considerably higher. Finally, the borrower would be required to purchase Private Mortgage Insurance which would increase the cost even further.

Another possible downside, you may also lose the tax benefits of a conventional loan. Interest paid on loans that are higher than the value of the home is not a tax deductible expense. And perhaps most importantly, there is the downside if you need or want to sell your home before you pay down the loan. A seller that needs to sell their home quickly due to financial or other problems could easily owe more on the home than the sale price, leaving them in a bind if they can't come up with the cash. The lender could foreclose on the loan or the seller end up in bankruptcy.

All in all, the risks of the no equity home loan can very easily outweigh the possible benefits. Unless you have done your research and understand the pitfalls, these types of second mortgages should be avoided rather than put your home at risk.