With sub-prime financing so hard to find, hard money lenders are stepping into the gap created by their absence. And if you have plenty of home equity, these folks may be willing to refinance you and significantly reduce your payments. But they may exact a high price in terms of your home equity. How do they do it?

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Equity strippers take it all off

Here's an example. A homeowner with bad credit has a $100,000 mortgage at 10% on a house worth $200,000. A private lender checks the public records and sees that there is a lot of equity in the home and they approach this homeowner with a proposition. They claim that they can cut their interest rate in half and the borrower won't have to pay a cent! Can they do this? Probably.

Here's how it works. A homeowner who got a sub-prime mortgage at 10% a few years ago would have been able to get a prime loan at 6.5% if his or her credit had been better. Today, with prime rates at about 4.25%, sub-prime borrowers would be paying about 6.75% -- if sub-prime loans were available. So a hard money lender could shave several hundred dollars a month from the borrower's payment legitimately. But an equity-stripper will go further.

Less sophisticated homeowners look at three things when they refinance -- the payment and interest rate and what they have to pay at closing. Equity strippers charge very high fees -- in this case about $10,000, which is 10 points -- and roll that into the new loan. So the new loan amount is $110,000, not $100,000. $10,000 in equity is stripped from the home and the owner may have no clue.

If someone approaches you about refinancing, be very careful.

Reputable lenders (like those on this site) are licensed and have to meet ethics and education requirements to conduct business. Private lenders are not regulated to nearly the same degree. If you use a hard money or private lender, look carefully at the costs of whatever loan you are offered, and check the difference in your mortgage payoff and the new loan amount. That difference will be paid in cash to the new lender and comes off the top of your home equity.