Typically, people borrow money (a mortgage) to buy a home and pay it off over many years. Also typically, home values increase over time. Homeowners then, could build equity in two ways.
- They chip away at their mortgage principle, and
- The increasing value results in increased equity for the homeowner, often quite substantially.
While this works great for homeowners, us bankers want a piece of the action. Why should the homeowner get all the benefit of that increased equity? So, we came up with home equity loans. We like getting homeowners to think of their homes as private ATMs. It’s pretty simple; we lend you money based on the equity in your home, at a higher rate than a primary mortgage, and you agree to offer that home as security. We run ads tempting you to buy all kinds of things and pay for it with your private home ATM. We try to make you think it’s quite normal and financially sound to keep borrowing against your equity. We encourage the thinking that homes always go up in value such that the borrowed money you spend will be readily replenished by the value increase. What can go wrong?
We certainly don’t talk about the relatively high interest rate, the fact that sometimes homes go down in value, and especially the part about how we can take your house away if you don’t pay. So we get nice interest, occasional late fees, and have almost no risk. We win again.
There are lots of other ways we bankers have figured out how to make money from our unsuspecting customers. For example: