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Dr. Don Taylor, CFA, Bankrate.com advice columnistGetting out of a line of credit, or HELOC

Dear Dr. Don,
I have a home equity line of credit (HELOC) for $30,000 that I took out a few years ago during my first refinance to get rid of my original 80/15/5 situation. We wanted to get rid of that 15 percent 30-year term loan, so we went with the line of credit.

Unfortunately, it's tied to prime (prime plus 1 or 2) and has skyrocketed our payments due to the recent rate hikes. Any advice on how we can get rid of this line of credit through a no-cost refinance to a low, fixed rate that's more beneficial and still offers the tax benefits? Our balance is $20,000.
-- Michelle Mortgages

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Dear Michelle,
There are a lot of people out there in your situation, even though you got there in a fairly novel way. I'm assuming the refinancing took you from a home equity loan to a home equity line of credit at a point in time when there was a pretty big difference in the interest rates on the two loans.

As I write this, the interest rates on the two loans are very close, with the national average for a home equity line of credit at 8.19 percent and the interest rate on a home equity loan at 7.92 percent. If you pay prime plus 1 percent to 2 percent, and the prime rate is currently 8.25 percent, that makes the interest rate on your loan 9.25 percent to 10.25 percent. 

Depending on your credit score and income levels, switching back to a home equity loan could give you a little relief if you would qualify for a home equity loan at a rate close to the national average. Going from 9.25 percent to 7.91 percent reduces your interest rate by 1.34 percent and converts it to a fixed rate.

If you got the line of credit a few years ago, the loan should be past any prepayment penalty period. Still, it's a good idea to confirm that either by reviewing your loan documents or asking the lender. Closing costs on home equity loans typically are quite low, so you shouldn't have to chase the illusion of a no-cost loan, which doesn't really exist -- the fees are just built into the loan somewhere else.

Depending on how your first mortgage is structured and the interest rate on that loan, it could make sense to pay off the HELOC with a cash-out refinancing of the first mortgage. That's especially true if you've built up enough equity in the home that the new mortgage wouldn't require private mortgage insurance, or PMI. The national average for a 30-year, fixed-rate mortgage is 6.51 percent. 

The downside to that recommendation is that closing costs in refinancing a first mortgage are fairly expensive. Bankrate's annual survey of closing costs is just out. If you don't plan on being in the house for long, or you have a very low interest rate on your existing first mortgage, then a cash-out refinancing isn't for you.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: Aug. 23, 2006
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