|Synopsis: Facts to consider when looking at tapping your equity to finance relocation. Understanding these facts can prevent your making costly decisions on the one hand, and help you make profitable decisions on the other. Most equity tapping situations are conducted in the wrong way and for the wrong reasons. This article helps you sort all that out so you do things the right way.|
Consumers enjoying increased equity
in their home don't always make the best decision about how to tap
In a during the first quarter of 2000, 79 percent of Freddie
Mac-owned loans were refinanced with loans that were at least 5
percent larger than their original mortgage, compared to 57 percent
during the first quarter of 1999. Among those who refinanced
fixed-rate mortgages, they refinanced with loans that were a median
0.3 percent more expensive than their original loan, according to
Refinancing is down overall, due to higher interest rates, but home
owners who did refinance did so to tap the median 27 percent increase
in home equity during the first quarter this year, compared to 11
percent in the first quarter last year, Freddie Mac said.
How best to tap that equity demands a look at the options. You have
three basic choices. Here's a look at some of the pros and cons your
should consider for each type.
When you refinance your original mortgage, you swap it for another,
often because the rate of the new mortgage is cheaper. If you
refinance your existing mortgage, along with some or all of the
equity, you can then take out the equity as cash to use as you wish.
Pros: If your original mortgage's interest rate is higher
than prevailing rates or carries an adjustable interest rate that has
been trending up, a cheaper fixed rate can cost you less each month --
even if you take out a
little equity -- and you needn't worry about future increases in your
Also, if you made a low down payment on your original first
mortgage and had to pay private mortgage insurance, the refinanced
mortgage could rid you of that extra expense, provided your new loan
is 80 percent or less than the value of your home.
Compared to your other two equity tapping choices, this choice
comes with only one monthly payment.
Cons: Today's interest rates could be more expensive and
that could cause a higher monthly bill, especially if you tap the
equity. A refinanced mortgage is more application intensive than other
options and the cost can include points (each point is one percent of
the financed amount) other loan charges and escrow fees and time,
nearly as much as your original loan.
Unless you cut the term to say to 15 or 20 years, a refinanced
mortgage is like starting all over again with a 30-year mortgage.
If you choose an adjustable rate mortgage (ARM), to offset the
possibility of higher payments, you'll have to prepare yourself for
the inevitable adjustments upward. If you want to borrow more than 80
percent of your home's value, the other options could be better
Home equity loans
With a home equity loan you don't touch your original mortgage, but
borrow cash against your equity.
Pros: The simplest and perhaps the most lucrative way to tap
your equity, some second mortgages allow you to borrow money that will
bring your total indebtedness on your home up to 125 percent or more
of its value. You can pay back the lump sum in monthly installments,
usually for a fixed rate, over a fixed term, usually from 10 to 20
Cons: Home equity loans rates can be one to several points
more expense than interest rates on a refinanced mortgage. If you
borrow more than your home is worth, you may not be able to afford the
payments and you won't have any more equity to tap should an emergency
You may not be able to deduct all the interest. Joint tax filers
mortgage interest deduction is limited to the lesser of a $100,000
maximum and the home's fair market value determined by a complicated
formula in IRS Publication 936 ''Home Mortgage Interest Deduction.''
Beware of second mortgages with blimp-sized balloon payments and
If you're borrowing cash to pay for your kids' education some time
in the future, or for a long-term remodeling project, this loan
probably isn't for you. You'll be making payments right away for money
you haven't spent.
Home equity lines of credit
"HELOC" for short, home equity lines of credit begin with
a quick approval. Few, if any, up-front costs and the lender hands you
a checkbook, credit card, or some other method to access to your
equity money. Working much like a credit card, you dip into the till
only when necessary.
Pros: You don't get dinged for interest until you actually
use your cash. That's a handy financial tool to have, say, for a home
improvement project you pay in installments. You generally won't be
saddled with a large prepayment penalty if you only need the money for
a short time. Low introductory variable rates let you use money for
less than if you opted for a fixed-rate home equity loan. Other
flexible features can be built into your HELOC. For instance, if you
pay off your balance, your line of credit can remain available for the
life of the line of credit.
Cons: Lines of credit can get expensive. HELOCs are almost
always adjustable rate loans with periodic interest rates charges
continually applied to your loan balance, much like a credit card.
While the rates are much less than most credit cards, they do
"feel" like a credit card and temptation could cause you to
use it much like you use your plastic -- for every day shopping. Each
withdrawal could come with a fee and if you reach your limit, you
could be short should a real emergency arise or it comes time to pay
for a big-ticket item.
Written by Broderick Perkins