Taking Out an HELOC for Emergencies

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A home equity loan can be a lifesaver, used to pay down high-interest credit card bills, put a child through college, pay for home expansion or help the homeowner weather a financial rough spot.

In a shaky job market, it may make sense to take out a home equity loan as a precaution, else the lack of income prevent you from qualifying after a pink slip comes.

But it’s not a move to be taken lightly. Saddling your home with a second loan could prevent you from using a last-ditch exit strategy in a financial crisis — turning your home over to the lender with minimal consequences to your credit rating.

A growing number of mortgage lenders are offering “deeds in lieu of foreclosure,” an easy way out for borrowers behind in payments. Instead of going through the torturous foreclosure process you could simply hand over the keys. In many cases, the lender will allow the homeowner to remain in the property briefly, or to rent it at a market rate. Some lenders even provide a modest sum to help the homeowner relocate.

A deed in lieu of foreclosure is a black mark on your credit history, but may not be as bad as a standard foreclosure. Experts say the homeowner should try to negotiate with the lender over how the event will be reported to credit agencies.

The best option is “paid as agreed,” followed by “paid settlement” then “foreclosure.” With a “paid as agreed” report, you’d be eligible for a Fannie Mae mortgage in four years after giving up your home, while it would take five years after a foreclosure. With extenuating circumstances, such as a job loss or major medical problem, the Fannie Mae waiting period could be as short as two years after a deed in lieu of foreclosure, three years after a foreclosure.

There’s no way to force the lender to agree to a deed in lieu of foreclosure, and it may be difficult if you owe more than the property is worth. But it is an option worth exploring. It’s less of a hassle than a short sale, in which a home is sold for less than is owed, with the lender agreeing to settle the debt so long as a minimum price is received. A deed in lieu of foreclosure allows the lender to get the home on the market faster than in a foreclosure, so lenders have an incentive to consider it.

Unfortunately, a home equity loan can block a deed in lieu of foreclosure, as the second lender has rights, too.

A homeowner who has kept up with payments but wants to prepare for the worst could have it both ways by taking out a home equity line of credit rather than a home equity installment loan. Typically, an installment loan is a lump sum received soon after the loan is approved. Payments begin almost immediately, and the obligation could thus hinder a deed in lieu of foreclosure if the homeowner’s situation worsens.

A home equity line of credit, or HELOC, works like a credit card. Once approved, the homeowner has the right to borrow up to the limit. Payments, of course, don’t begin until you start using the credit line. A line of credit can serve well as an emergency reserve. Use the search tool to find a good home equity loan. Many HELOCs charge less than 4%, while installment loans charge more than 8%, according to the BankingMyWay.com survey.

A homeowner who runs into financial trouble and has a HELOC can choose to tap the line of credit to get over the rough spot, or cancel the credit line and pursue the deed in lieu of foreclosure. In a crisis, the more options the better.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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