Paying off your mortgage with a home equity loan
Bluemortgage.com - 2/20/2003
For quite a while, Jerry and Staci Reichelscheimer wanted to
refinance their mortgage to get a lower rate. But they
balked at the closing costs. Then they had an idea -- why
not pay off their mortgage with a no-cost home equity loan?
So they did. They got a home equity loan with no closing
costs and used the proceeds to pay off their primary
mortgage, effectively turning their equity loan into a first
mortgage. What the Reichelscheimers did might not work for
you, but it demonstrates the value of thinking creatively
about how to manage your debts. Using a home equity loan to
pay off a primary mortgage is a recent phenomenon that "has
come on my radar screen lately," says Bob Walters, senior
vice president of secondary marketing for Quicken Loans.
Such a transaction makes sense for two kinds of borrowers,
he says. The biggest group comprises people who don't owe
much on their mortgages. The other group consists of
affluent and financially savvy homeowners who can afford to
take some risks. Retire a small mortgage Of the first group
-- people with small mortgage balances -- Walters brings up
a hypothetical case of someone who owes $23,000 and is
paying at a rate of 8 percent. It would be hard to find a
lender that would bother with refinancing such a small
amount, and then the fees could easily exceed 10 percent of
the loan amount. The way around the low-balance roadblock is
to get a no-fee equity loan or line of credit to pay off the
first mortgage while getting a lower rate. Walters calls
this the "cleanup mortgage." Then there's the cross between
a cash-out refinance and an equity loan. Tom Drennan,
executive vice president for mortgages at Astoria Federal
Savings in Lake Success, N.Y., says a recent customer owed
$7,000 on a mortgage and got a $25,000 equity line of
credit. After paying off the first mortgage, the borrower
has $18,000 remaining on the line of credit. Fees were
minimal. Manage a big mortgage At the other end of the
spectrum are homeowners with big balances and expensive
houses. These homeowners can pay off their primary mortgages
with home equity lines of credit, or HELOCs. The advantage
of a HELOC is a low rate. The disadvantage is that the rate
is variable, and as this article is written in February
2003, HELOC rates have nowhere to go but up. "Taking out a
HELOC at these terrific rates, they are saving tons on their
mortgage," Walters says. But these borrowers have to be able
to "take on the economic changes" when rates rise. A HELOC
usually requires you to pay only the interest on the
outstanding balance, so you have to exercise self-discipline
to pay principal. And the entire amount can come due when
you sell the house or at the end of a specified repayment
period, often 15 years. The Reichelscheimers fit into the
big-balance category. Instead of getting a HELOC, they got a
fixed-rate home equity loan. They're confident that they
made the right choice, considering all the circumstances.
They have owned their two-story Victorian in Melville, N.Y.,
since 1998, when they got a 30-year mortgage at 7 percent.
In the summer of 2002, the house was worth about $500,000 to
$550,000 and they owed $241,000 on the mortgage. They
searched around for refinancing deals, but were turned off
by the fees, which would be at least $3,000 -- plus New
York's mortgage-recording tax of 0.75 percent of the loan
amount, which would amount to another $1,800. Then they saw
an advertisement for FleetBoston Financial's 20-year home
equity loan, which is marketed as a way to refinance and
consolidate debt without paying points or closing costs. In
July 2002 they traded their 30-year, 7 percent loan for a
20-year loan at 6.25 percent. Two months later, they
restructured the home equity loan to get a rate of 5.99
percent. Their monthly payments are almost the same, but
they cut years off the repayment period. "Could we have
gotten a 20-year at 5.5 (percent)? It's a possibility,"
Jerry Reichel Scheimer says. But the lower rate would have
come at the expense of thousands of dollars in fees. Before
homeowners take out equity loans to pay off their mortgages,
they should take a look at no-closing-cost refinancing, says
Brian Peart, president of Nexus Financial, a mortgage
lender. With these loans, the lender pays the closing costs
and charges a slightly higher interest rate. Under some
circumstances, this can result in lower monthly payments
than rolling the closing costs into the loan at a slightly
lower rate.
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