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The 125% home equity loan is among the more recent concoctions brought forth by lenders anxious to reel in second mortgages, now that the sale of homes has been stalled for over a year. This loan essentially allows you to take out a second mortgage that, when added to the debt remaining on your first mortgage, totals 125% of the home's current appraised value. The reason that home equity loans have been so popular is that the steep rise in home values allowed people to take out loans secured by the equity created by the raised valuation. Secured loans are much cheaper than non secured loans. In addition, second mortgages (the same thing as a home equity loan) carry tax deductible interest just as the primary mortgage does.
A 125% home equity loan is neither secured, nor cheap, nor completely deductible. The IRS allows deductions on home loans only on debt that equals the value of the home. In the case of a 125% home equity loan, the interest paid on that last 25% is not tax deductible. Because a substantial portion of the loan is not secured, the interest rate is going to be higher than a secured home equity loan. The average interest rate for a secured home equity loan is about 7.75% in May of 2007. One highly advertised offering for a 125% home equity loan from a national mortgage company is a 25 year loan at 12.75% in interest with a 13.365% APR. That APR reveals that the fees involved in obtaining this loan are substantial. Many people who opt for a 125% home equity loan do so because they are in serious financial difficulty. They may use the funds to pay off credit cards with an interest rate of 18%; that may look like a net savings. But it is important to keep in mind that you will be paying almost 13% interest on the borrowed money for a long time. 125% home equity loans may also come with a requirement for mortgage insurance, which will be an added monthly expense.
The other issue that many financial experts point to regarding these loans is the fact that they strip the homeowner of any mobility. In order to sell the home and move, he/she would be obligated to sell the house for its appraised value (in a slumping housing market) and make up the remaining debt on the home in cash. Few people who go into loans like this have the cash in the bank to close out a deal like this. A 125% home equity loan is, to most prudent observers, an expensive option that serves as a last resort.
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