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How Foreclosure Default Increases will Affect Home Equity Loan Rates

According to RealtyTrac, an online marketplace for foreclosure sales, the number of homes entering into some stage of foreclosure is surging. A survey released in September, 2006, indicated that 115,292 properties entered into foreclosure in August. That was 24% above the level in July and 53% higher than a year earlier. How does this affect home equity loan rates? Before answering that, let's get an understanding of what a home equity loan is.

Consumer Action, a national non-profit advocacy and education organization, defines a home equity loan as a loan against your home's equity. Equity is typically calculated using the estimated value of the house minus the amount you still owe. A home equity loan, like your mortgage, is a secured loan. Your home is the collateral used to guarantee the repayment of the loan. If you can't make the home equity loan payments, you can lose your house.

Lender Risks

Although your mortgage lender can foreclose, they still assume a big risk when lending to you. A foreclosure entails taking your property and selling it at the highest possible price. The proceeds from the sale are then used to recoup the lender's losses. Foreclosed real estate typically sells for less than the current market value, especially in a soft market, so lenders usually take heavy losses by foreclosing on homes. It's an even greater loss for home equity lenders. Why?

Home equity loans are also known as "second mortgages"--they are a secondary lien on your house. Your first mortgage lender has the first lien on your home. So, if your home also has a second mortgage, the 2nd lender stands a good chance of getting very little to nothing from the foreclosure because they have to wait until the first lender collects their share before trying to get any money. This is why rates on 2nd mortgages are higher than those of first mortgages--the increased risk to the lender. That risk increases exponentially as more home loans foreclose.

How Will This Affect Home Equity Rates?

Foreclosure defaults rising will cause the interest rates to rise for home equity loans to help offset the exponentially increased risk. It will become more difficult for a first time homebuyer to get a second mortgage. Low loan to values will be needed to access more money, and borrowers will need more equity before being considered for a loan. Home equity credit line rates could be dramatically affected if the foreclosure ratios gets out of hand

The good news is that home equity rates are still low. So, now may be the time to get that home equity loan to remodel your home or consolidate those high-interest credit cards--before rates are affected by the rise in foreclosures.