|
|
||
|
|
||
How to save on your home-equity debt |
|
|
Thanks to an odd twist in interest rates, you could save thousands each
year just by converting your home-equity line of credit to a closed-end
loan or refinancing your mortgage to pay it off. By Liz Pulliam Weston People with big home-equity debts may have an unusual opportunity right now to lock in some savings. The rates on home-equity lines of credit, generally referred to as HELOCs, have climbed two full percentage points in the past year and are expected to rise some more. At the same time, longer-term mortgage rates have dropped. This has created a rare situation where long-term borrowing can cost less than short-term borrowing. As a result, some mortgage experts are recommending that those with big HELOC balances consider locking in current rates -- either by converting their debt to a closed-end home equity loan or by refinancing their primary mortgage to a larger loan that would encompass the home-equity debt. "We're talking about going for the safety of a fixed rate, while the getting's good," said Jack Guttentag, a nationally syndicated mortgage columnist and professor emeritus of the Wharton School of the University of Pennsylvania. "I think a strong case can be made for that." Greater equity risk with HELOCs HELOCs, a kind of adjustable-rate mortgage that allows homeowners to borrow against the equity in their home, expose borrowers to more interest-rate risk than most other kinds of mortgages, Guttentag said. They typically have no payment caps and their maximum interest rate is high -- usually 18% or more. Furthermore, HELOCs respond quickly to changes in short-term rates.
"If the prime rate goes up on a Monday," Guttentag said, "your (HELOC) rate is up on Tuesday." Closed-end home-equity loans, by contrast, offer a fixed rate (currently averaging just over 7%, compared to about 6.25% for the average HELOC after its teaser rate expires). You may face higher payments, though, because home-equity loans require principal payments as well as interest. (HELOCs typically require you to pay only interest in the initial years). Wrapping your HELOC into your mortgage The other option: paying off your HELOC balance with a cash-out refinancing of your primary mortgage. Related news and commentary on MSN Money Here's how it might work. A couple with a $75,000 HELOC balance at 7% might refinance their $200,000 mortgage into a new, $275,000 loan at 5.5%. They might not save much on their original loan, particularly if it already had a low rate. But they've nailed down a lower rate on the HELOC debt that could save $1,125 a year. If short-term rates continue to climb this year, as many experts expect, the savings could be even greater. "The thinking is that the Fed will raise rates another quarter point at the end of the month, and there may be another couple of increases beyond that," said mortgage broker Allen Bond, who serves on the California Assn. of Mortgage Broker's board of directors. "So you could be looking at rates that are three-quarters to a point higher by year end." Will it pay off for you? Whether the math works for you, however, depends on a number of factors: How much do you owe? The smaller your balance, the less your exposure to interest-rate risk -- and the less sense it makes to bother with a cash-out refinance. You might decide to convert a $10,000 or $20,000 HELOC balance to a closed-end home equity loan, but you need a bigger balance to justify the costs involved with a refinance, Guttentag said. "We're really talking about balances over $50,000," Guttentag said. What's your rate? If you have good credit and plenty of unused equity, your HELOC rate might be at 6% or less. In that case, it's harder to make the case for refinancing since you won't be saving that much initially. The higher your current HELOC rate, the more likely to you are to realize at least some savings with a closed-end loan or a cash-out refinance. Similarly, you might save with a cash-out refinance if you're paying a higher-than-average rate on your primary mortgage, perhaps because you had poor credit or a small down payment when you applied for your current loan. If your credit has improved and your home has appreciated, you might get a rate low enough to make refinancing appealing. How long do you plan to have the debt? Refinancing might not make sense if you're planning to move or pay off your HELOC debt within a few years. The case for grabbing a low rate becomes more compelling the longer you plan to have the debt and your home. I'd like to add my usual caveat for folks who have drained their equity to pay off credit-card bills and other frivolous spending. Most times, that's not a great idea (see "The 3 worst money moves you can make") and dragging your heels when repaying the debt makes it even worse. You'll be increasing your total debt repayment costs while tying up precious home equity, which can serve as a cushion in a financial emergency. "You're taking what conceivably could be a 5-, 7- or 10-year debt and turning it into a 30-year debt," said mortgage expert Don Petrasek of EducatedHomeBuyer.com. "You'll pay more and you'll be cutting yourself off from an important source of funds." What's your tolerance for risk? No one can predict where interest rates will be a year from now. If the possibility of a higher HELOC rate already has you sweating, you might want to lock in today's rates. If, however, you think rates might eventually drift lower within a year or so, you might want to pass. "You really have to weigh what your risk aversion is," Bond said. "Is it worth it to you to go through the refinance to get the lower rate?" How much will your refi cost? Getting a closed-end home equity loan is usually pretty cheap, since there are minimal upfront costs. But the typical mortgage refinance can cost 3% to 5% of the amount borrowed, according to the National Association of Mortgage Brokers, and that could wipe out any potential savings on your HELOC debt for several years. You can opt for a loan that doesn't have upfront costs, but those typically come with higher interest rates, which also would reduce your potential savings. The only way to really know if a HELOC refinance will pencil out for you is to crunch some numbers. You'll need to get some quotes from lenders showing you what rates you can expect and what costs you'll face. Then you'll need to balance those expenses against the savings you expect to reap over the years you plan to have the new loan. "With the Fed raising rates, I think it's something to consider," Bond said, "but it's not going to make sense for everyone." Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board. |
