Negative amortization on a Home Equity Loan
Negative amortization
If you think that’s bad, it could be worse. Sometimes, your monthly payments on a home equity loan don’t even cover all of the interest you owe.
That means interest continues to accrue and the total amount owed rises – even though you’re not borrowing any more money.
For example, $20,000 borrowed at 10 percent over five years would require monthly payments of $425 to wipe the balance sheet clean by the end of the term. But say your loan amortizes negatively (meaning you’re not covering the full tab), and your monthly payments are $150 apiece. At the end of five years, instead of owing nothing, you’ve paid $9,000 back, but you owe $21,000. That’s because you still owe the principal plus additional interest that has accrued over the term of your loan.
This type of predatory lending occurs less frequently with home equity loans today than it did five years ago.
Another pitfall may arise when homeowners take out a home-equity loan to finance home improvements. While remodeling the kitchen or bathroom generally adds value to a house, improvements such as a swimming pool may be worth more in the eyes of the homeowner than the market determining the resale value. If you’re going into debt to make cosmetic changes to your house, try to determine whether the changes add enough value to cover their costs.
Paying for a child’s college education is another popular reason for taking out home-equity loans. If, however, the borrowers are nearing retirement, they do need to determine how the loan may affect their ability to accomplish their goals. It may be wise for near-retirement borrowers to seek out other options with their children.
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