(Updated January 2015)
You've spent years paying down the mortgage on your home and building up its equity. Now, you find yourself in a situation where you need to take advantage of what you've built. There are many reputable lenders who'll give you a home equity loan to make use of that available cash stream. However, there are also a number of scam artists who may try to relieve you of your hard earned money by stripping all of the equity from your home.
Preying on needy homeowners
Once you decide that tapping into the equity in your home would make it easier for you to meet your financial obligations, you find a lender and start the application process. In an equity stripping scam, the lender doesn't have your best interests at heart.
Here's how it works: The lender convinces you to take out a loan with monthly payments that are too high for your income. The loan is approved, because the lender reports your income as higher than it actually is. After a few months, you fall behind in your home equity loan payments. The lender forecloses, and you lose your home.
This sort of arrangement is far less common these days, given that underwriting standards for mortgages are considerably tighter than they were before the crash. Most home equity loans will require stringent proof of income these days, particularly if the loan is backed by Fannie Mae, Freddie Mac or the FHA, as most home equity loans are. However, loans issued through the private money lending market have no such restrictions, and it's possible to get in over your head there.
Scams and foreclosure
Another variation on the equity stripping scam is the "mortgage rescue." In this scam, a homeowner in financial trouble is contacted by an individual or business offering what are described as foreclosure rescue services. They tell the homeowner they can avoid foreclosure through sophisticated financial maneuvers, which in reality are a cover for a scam.
These scams depend on desperate homeowners who are looking for help and can be persuaded to sign documents they don't fully understand.
The way this usually works is that the scammer offers to be an intermediary between the homeowner and their lender. The homeowner is convinced to sign the property over to the scammer, who promises to take over the mortgage payments and rent the property back to the consumer.
One way this ends is that the scammer pays off the mortgage balance and gets title to the house free and clear - including any equity the homeowner may have built up. They then either evict the homeowner or continue to rent it to them but without the homeowner ever recovering any ownership stake in the property.
Another version is that the homeowner is simply told to relay their mortgage payments through the scammer, who purportedly will handle all contact with the lender. In reality, the scammer simply pockets the payments and tells the borrower to ignore any collection or foreclosure notices. As a result, the homeowner either ends up even further behind on their mortgage or loses the home to foreclosure entirely.
Home repair con
In another variation, an older homeowner is contacted by a contractor who informs them of an opportunity to have repairs or home improvements done with no credit check, income requirements or monthly payments, thanks to a special FHA program. The homeowner receives the impression the repairs will be done at no cost due to government funding.
What actually happens is that the homeowner is encouraged to fill out paperwork for a Home Equity Conversion Mortgage (HECM), also called a Reverse Mortgage, with the proceeds paid to the contractor. These are special FHA loans for senior homeowners that allow them to borrow against the equity in their home with no requirement the loan be repaid until the property is sold or vacated. However, in this situation the homeowner is unaware they are actually borrowing money that will reduce the equity they have in their home, including the interest debt that will build up over time.
The Cleveland Office of Consumer Affairs issued a consumer alert for this type of arrangement in 2014 after a number of senior citizens were taken advantage of. In some cases, contractors performed little or no work.
It should be noted that Reverse Mortgages can be a legitimate means for senior homeowners to tap their home equity for repairs or other expenses, but that the con in the above situation occurs when they are unaware they are completing paperwork for such a loan.
Whenever you're considering using your home's equity, research home equity loan rates and lenders to be sure you're getting the best deal on home equity loans. Never sign a loan agreement without making sure that you understand all of the terms, or you may be stripped of your dignity along with your equity.