If you're considering an ARM, you'll want to check out HSH's comprehensive Guide to Adjustable Rate Mortgages.

If you're considering an ARM, you'll want to check out HSH's comprehensive Guide to Adjustable Rate Mortgages.

Home Equity Loans & Today's Home Buyers

Unlike someone who bought a house in 2006 at the top of the market, if you buy a home with today's depressed prices, you stand a good chance of having and building equity in that home sooner. That's true especially if the right home improvements are undertaken on starter properties with potential.

Cheaper Homes for Sale May Mean More Home Equity Sooner

Industry analysts expect that in the next year or so, more and more bank-owned properties will come onto the market at below-market prices. First-time home buyers, even without additional extensions of the $8,000 first-time home buyer credit, should be prime candidates for purchasing those below-market price homes, and today's tight lending conditions require that they make at least some down payment.

Downpayment = Instant Equity

The same dollar amount of down payment in a market with lower housing prices means greater equity up front and lower loan-to-value ratios. A portion of this next generation of first-time homeowners, in other words, may possess some or even considerable equity in their homes within the next five years.

Will these homeowners be willing and quick to use this equity to take out home equity loans, after seeing the problems of the past two years with regard to vanishing home equity?

Home Equity Loan Cautionary Tales Abound

Today's young couple that takes out a mortgage loan--particularly an FHA loan with a low down payment--should be aware that home equity is not something to be used lightly. It became clear that market conditons can quickly wipe out an equity stake. Before taking out a home equity loan, today's first-time home buyer should carefully consider the following:

  • Closing costs of a home equity loan. Costs to close the loan will eat into the amount you are taking out. If closing costs are rolled into your home equity loan, you're still paying for them, even if not today.
  • Variable interest rate vs. fixed interest rate. Today's interest rates are low, but some low-rate home equity loans come with variable interest rates. If you take a variable-rate loan, make sure you understand how the rate resets and what rate caps exist. Initial rates may look attractive, but they're likely to go up from here.
  • Purpose of the home equity loan. Are you taking out the loan for an investment such as education, home improvement, or to cover unavoidable expenses (such as medical bills) that would result in financial disaster otherwise? It's not a good idea to risk your home over needless lifestyle expenses.
  • Size and mortgage rate of existing first mortgage. Even if you can qualify for a home equity loan, you should know whether the level of debt you are taking on will be manageable given your income and assets.

Home Equity Loans Still Highly Appealing

Though they may be more cautious, today's home buyers will not forsake the home equity loan as an option for managing their finances. Low mortgage rates on home equity loans will always present an appealing option to a homeowner with enough equity to qualify.

Given the events of the past year, however, we can only hope that the lesson has been learned and that the next generation of homeowners will use home equity loans cautiously and productively.

Andrew Freiburghouse is a writer and a businessman. As a partner at Los Angeles tax preparation firm Pronto Income Tax of California, Inc., Andrew has advised thousands of clients on a variety of financial matters.

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