The soon-to-be bride had no choice.
The balance on her dress was due, the caterer wanted his money and the DJ wasn't playing for free. Without the cash to pay upfront, she did what anyone might do -- she put it on plastic.
A year after the wedding, Bridgette -- who asked that her last name not be used -- found herself with $12,000 in credit-card bills in addition to an $18,000 balance on a home-improvement loan. Wanting to consolidate her bills and decrease her monthly debt payments, Bridgette went to the bank and got a home-equity loan for $26,600.
What makes her situation unusual is that she had only about $12,000 worth of equity in her home.
Bridgette is one of the 350,000 Americans who, this year, took out an increasingly popular type of loan that allows consumers to borrow up to, and sometimes more than, 125 percent of the value of their houses, rather than the typical 80 percent limit. She and her husband now owe $81,000 on their east Baltimore County rowhouse, which is appraised at $67,000.
Because such "no-equity loans" come with lower interest rates than most credit cards, about 13 to 15 percent, and they let consumers spread payments over 15 years, they can bring instant relief to people whose monthly bills have gotten out of control. Bridgette's payments on her credit-card debt and home-improvement loan dropped from $1,000 a month to less than $400.
"Money only goes so far," she said, "and this loan helped us a lot."
But such loans come with drawbacks that some consumer advocates and mortgage brokers say outweigh their benefits.
The loans make selling a house and buying a new one more costly -- if not impossible.
Refinancing to a lower rate is out of the question, since most lenders will go only to 90 percent of the home's value.
People who pay off their credit cards with the loan and then head right back to the department stores and ring up another huge balance will be in worse financial straits than before -- and this time their houses are on the line.
"We always felt that sort of loan-to-value ratio would put a burden on our customers," said Tony Mattera, spokesman for Crestar Bank, which discourages no-equity loans. "When you go to sell your home, it's possible you'll have negative equity and have some gigantic out-of-pocket outlay in order to sell your home."
Some lenders may let people transfer the loan to a new home. Other lenders, however, require the no-equity loan to be paid when a homeowner decides to sell.
If Bridgette sold her house today at the appraised value, for example, she'd likely have to come up with $14,000 to pay off the no-equity loan.
The loans also raise issues for people who want to refinance. Banks and mortgage brokers generally don't retain and service mortgages that they make.
Instead, they sell them on secondary markets, and government-chartered agencies Fannie Mae and Freddie Mac are by far the largest buyers. So most lenders must make sure their loans conform to Fannie Mae and Freddie Mac guidelines. Both agencies frown on loans that put people in a position of owing more than 90 percent of a home's value.
"What consumers should be asking is, even if it's portable, will I have trouble with my next first mortgage?" said Neil Sweren, president of American Home Loan Inc. and past president of the Maryland Association of Mortgage Brokers. "If they want an FHA or Fannie Mae or Freddie Mac first mortgage, they might have problems. It's hard to tell how big of a problem it is, I don't think they've [no-equity loans] been around long enough to really tell."
Higher rates
Buyers can find lenders -- called sub-prime lenders -- who are not bound by Fannie Mae and Freddie Mac's standards, but the interest rates generally are higher. For example, First Plus Financial Group of Dallas, the largest no-equity home loan lender, also offers 30-year first mortgages. But they generally run about 10.6 percent, while conventional 30-year mortgages now average about 7 percent.
John Hauge, a group executive of financial strategies at First Plus, said his customers have already entered the world of nonconforming loans when they take out a no-equity loan, so the Fannie Mae and Freddie Mac guidelines are irrelevant.
"If they wanted to do that [obtain conforming first mortgages] they would have taken steps prior to coming to us and not run up credit-card debt," he said.
"Our loan enables people to get ahead," said Bill Benac, First Plus' chief financial officer. "When payments drop from $1,000 to $500, a borrower suddenly has a considerable amount of disposable income and it gives them the room to breathe that they need. Over time, the credit ratings of our borrowers tend to improve, not deteriorate."
A recent study by Brittain Associates of Atlanta found that in the past two years more than 4 million households have used home-equity loans -- including traditional and no-equity -- to pay down credit-card balances.
Started charging again
Of those, 2.5 million began charging again within months and racking up more credit-card debt.
The no-equity loan "can be wonderful for those who utilize it correctly," said Linus Campbell, director of education and marketing at Consumer Counseling Credit Service of Maryland.
"But some people will get the money, pay the bills, then start using the credit cards again -- the consequences are kind of dire. I personally would never recommend it to somebody who was not managing their money very well, because they're putting their house at risk."
Campbell suggests a visit to his nonprofit agency might be a better solution. The service has a public education program, counselors who offer detailed advice on how to manage finances, and its own debt-consolidation program.
"The problem is people are saying, 'I want one because my friend got one.' They've decided it's the greatest thing in the world, but they don't understand it and they don't ask questions," said American Home Loan's Sweren. "People focus on immediate results -- what's the payment going to be -- but they're not thinking about the results down the line. It's good for some people, but not everyone."
Log on to FirstPlus' Web site (www.firstplus.com) to read about debt-consolidation loans and you'll find enticing information about how to lower monthly payments from, as their example says, $970 to $299 -- payments "that may be tax deductible."
Tax deduction limited
An asterisked note at the bottom of the screen advises consumers to consult a tax professional for details. What that tax professional will tell you is that, yes, it's possible to deduct interest on home loans -- but only up to 100 percent of your home's value. The bulk of a no-equity loan isn't likely to bring tax relief.
Another aspect to consider is that because the loan is spread over a longer period of time, the monthly payments are lower, but in the long run consumers could end up paying more.
In Bridgette's case, had she kept working on her $30,000 debt at $1,000 a month with an average interest rate of 16 percent, she'd have it paid off in a little over three years.
Even an 18 percent rate would only add another two months of payments. But her no-equity loan from Provident Bank of Maryland, with an interest rate of 14.75 percent and monthly payments of about $370, will take 15 years to pay off. At the end of those 15 years she will have paid nearly $67,000 in principal and interest on the $26,600 loan.
"If people could pay off their credit cards they would, but they don't have the cash," said Joe Anderson, vice president of consumer lending at Provident, which does about 30 of the no-equity loans a month.
"Ninety-nine point nine percent of all the people that come to us have a need to consolidate. They have 401(k)s but not huge savings. They're looking to extend payments and be able to save money. I believe in it."
First Plus' Benac also believes in it. With 50 percent of the no-equity loan market, his company will do about $6 billion in the loans this fiscal year, up from $4 billion last year. And Benac sees no end in sight.
He said studies commissioned by the company show that, of the $500 billion in credit-card debt in this country, half is held by homeowners with good credit histories -- the type of borrowers First Plus is looking for.
"In issuing $6 billion in high loan-to-value loans this year, we're just scratching the surface," Benac said. "There's a lot of growth left."
No-equity checklist
TTC L Things to consider when contemplating a no-equity home loan:
A no-equity loan will make it more difficult to finance another home until a good portion of the loan is paid down, or your house has had rapid appreciation.
Refinancing first and second mortgages to take advantage of lower interest rates will be difficult if you have a no-equity home loan, since most lenders -- using Fannie Mae and Freddie Mac guidelines -- will not exceed a 90 percent loan-to-value on the home.
You'll be in worse financial shape if you use a no-equity loan to pay off credit cards and then start charging again. If you use the extra pocket money to pay off your no-equity loan more quickly, you can see actual savings. A no-equity home loan isn't an unsecured debt, as credit cards are. Fail to make payments and you could lose your home.
No-equity loans may offer some tax relief but, remember, you can only write off interest on payments up to 100 percent of your home's value. The rest is not tax deductible.
Pub Date: 8/30/98