Home equity loans remain one of the most popular financing tools among homeowners. It can give you quick access to cash by leveraging the equity (or ownership) you have in your home. It can be an effective way to finance a home renovation, education costs, or even a second home.
But these loans also get a lot of homeowners into trouble each year, and in the worst-case scenarios they can even result in foreclosure and loss of the home. On top of that, there are some common scams associated with equity loans and lines of credit. The Federal Trade Commission (FTC) is constantly tracking the latest scams and warning homeowners about them. Here’s a summary of some of the more common scenarios you should watch out for…
1. Equity Stripping
In this scenario, the lender will actually help you “pad” your stated income on the loan application form in order to qualify you for the loan. “Why would they do such a thing?” you might ask. Predatory lenders use this tactic because they don’t care about your actual ability to make the payments — they will simply foreclose on your house and benefit from the equity you’ve built up over the years.
If your income is outside of certain parameters, but the lender says “we can make that work,” you should already be on your guard. That’s red flag #1. If they try to persuade you that you can make payments that seem out of reach, you have another warning sign. You’re the only person who should be making decisions about your ability to pay back a loan!
2. The Helpful Contractor Scam
This scenario usually starts with a home improvement contractor (such as a roofer) who knocks on the door of homeowners to offer their services. Many of the homeowners will say, “Sorry, but that kind of project is not in our budget right now.” The contractor will counter this by saying he works with a lender who can help offset the cost. Long story short — the homeowner signs some papers that turn out to be a home equity loan.
This scam is not as common as it once was. But it still happens on a regular basis all across America, so it’s worth mentioning in our list. Unfortunately, as with many scams, the elderly are often the target with this approach.
The first thing you need to realize is that a reputable contractor will rarely practice door-to-door marketing. That’s the first red flag. Additionally, a contractor should never refer you to a third-party lender — it’s a conflict of interest. That’s the second red flag.
3. Loan “Stacking” or Flipping
I refer to this scam as “loan stacking,” because that’s what takes place. The more common term for it is “loan flipping.” Regardless of what you call it, the scenario goes like this. The lender will offer the homeowner a second equity loan after the homeowner has already received a first one (and made a few payments on it). Basically, the lender refinances the initial loan to grant the homeowner additional money.
In some cases, this will happen more than once. And with each new round of financing, the rates typically get higher and the fees larger. The borrower now has even more money to use for whatever prompted the first equity loan — but they also have a lot more debt spread out over a longer period of time. Homeowners who fall prey to this scam often get in over their heads with all the fees that stack up on them. It’s a good way to lose your home.
There Are Some Trustworthy Lenders
I don’t mean to scare you away from the equity loan as a source of financing. On the contrary, it can be a useful tool for a responsible borrower, and there are plenty of reputable lenders that will offer you fair terms and treatment. I’m simply trying to warn you about the common scams that go along with these types of loans.
My advice is to use a lender you’ve heard of before, a company who has been around for a long time and has a reputation at stake. Be a smart consumer when pursuing such a program. Do plenty of research and let common sense guide you.
Citation Note: The original version of this article was written by Brandon Cornett. Brandon is the publisher of the Home Buying Institute, which includes one of the largest libraries of mortgage advice for home buyers.