Here’s how you can clarify the situation and avoid confusion-related mistakes.
Home equity loans are a great way for your members to get money for needed expenses like home repairs or college tuition. They can also be used for things like vacations or new cars. The two types of home equity lending—closed-end home equity and open-end or home equity line of credit—each have marked differences. Misconceptions abound, in part because the two are so closely related. False assumptions are made by homeowners, which can result in mistakes being made by the lender. Let’s look at five common misconceptions and issues you can easily avoid.
1. The loan can’t be modified. While it is true that closed-end home equity loans cannot be modified, the same cannot be said for home equity lines of credit. The limit on the line of credit is based on the value of the owner’s home. If the value drops due to market conditions, the lender may have the right to adjust the amount of available credit accordingly. Not explaining this clearly up front could spell trouble for you in the long run. Make sure you do. Also, let your members know you may decrease the amount of available credit if you reasonably believe that the consumer will be unable to fulfill the repayment obligations because of a material change in their financial circumstances. For a no-modification option, steer them to a traditional closed-end home equity loan through which they receive a lump-sum payout and repay the money over time with a structured payment schedule.
2. A HELOC form can be used for CEHE lending, and vice versa. It is important to use the appropriate form for the corresponding loan type. Open-end home equity forms and closed-end home equity forms are very different. For instance, closed-end lending requires use of Truth In Lending Act/Real Estate Settlement Procedures Act integrated disclosures or “TRID” loan forms, while open-end lending requires forms like “Important Terms of our Home Equity Lines of Credit.” Certain states require additional disclosures. It is important to use the right set of forms so the loan can be drawn up properly, without error and to maintain compliance.
3. A HELOC is free. Make sure you do not pitch a HELOC as “free” or even close to free. Often, members may pursue a HELOC because they feel a need to have access to credit as a safety net. They go in thinking the HELOC is free and are hit with all sorts of “hidden” fees and charges. To that end, remind them that this method of lending, while not as costly as a traditional home mortgage, is not free. There are closing costs associated with the credit line, interest carrying charges and a minimum draw may be required at closing.
4. You can use all of the equity in your home. The HELOC agreement will state the maximum amount of credit that may be outstanding at any one time. Many lenders have limits that are based on loan-to-value and are sometimes further influenced by a member’s credit profile. There are other determinations as well. Make sure you fully explain your lending parameters for equity loans. This will set expectations before the underwriting process begins.
Also, make sure members understand that both types of lending are essentially treated as mortgage products, as they are pledging their homes as collateral. The same types of financial determinants used to approve a first mortgage will most likely be used to approve them for one of these two types of lending.
5. One is just as good as the other. Members walking into home equity lending for the first time might pose the question, “Isn’t one as good as the other?” Rather than agree, take time to explain the differences between each in terms of the member experience. Some borrowers favor a line of credit with multiple draws and changing payments while others prefer a structured repayment schedule. This is where dialogue is important. Talk with them and see what their actual needs are so they can make the best choice.
For instance, if a dream family vacation is in the works and the house needs to be painted, a closed-end home equity loan is probably the best option as it is easy to account for the fixed expenses. However, if a set of twins is starting college, a home equity line of credit is probably the better choice. In this scenario, expenses will fluctuate over a long period of time. The line of credit can be available for use over multiple semesters.
Referring to the list above will help your members choose the best home equity loan option with confidence. If your credit union does a good job, the end result will be a satisfied, loyal member. That is what it’s all about anyway, wouldn’t you agree?
Richard Gallagher, CEO of Oak Tree Business Systems Inc., Big Bear Lake, Calif., is no stranger to the credit union industry, having spent 26 years as senior executive where he oversees forms compliance, credit union merger guidance, expertise and policy considerations. Gallagher is one of the pioneers of digital forms conversion and data linking/integration for credit unions. He is also involved with Credit Unions for Kids.