| Home equity lines of credit: Keep
or refinance? |
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Take that hypothetical homeowner who still owes $30,000
on a line of credit and pays $193.75 a month just for interest.
If she converts it into a home equity loan at 7.75 percent -- one
that pays off the loan balance in 15 years -- the monthly payment
rises to $282.38. The payment is higher, but the loan eventually
will get paid off.
That borrower could simply keep
her line of credit and pay the higher amount every month, but there
are two problems with that. First, she might not have the self-discipline
to keep doing it. Second, the credit line's interest rate is likely
to rise even more (and later, to fall). The home equity loan, in
contrast, has a fixed rate, so the monthly payments remain the same
for the life of the loan.
Cash-out refinancing
The other way to handle a line of credit is to pay it off with a
cash-out refi. That's when you refinance your first-lien mortgage
for more than you currently owe, take the difference in cash and
use that money to pay off the home equity line of credit.
Paul and Lisa Boucher are going the cash-out-refi
route. The couple and their three children own a house south of
Provo, Utah. When they got their home equity line of credit to finish
the basement, the interest rate was 5.25 percent. Now it's almost
10 percent. But that's not their main worry. Their primary home
loan is a payment-option adjustable-rate mortgage, in which the
interest rate has risen from 5.75 to 6.5 percent since July. It
probably will rise more.
So they're refinancing -- switching the first mortgage
to a 30-year fixed, probably at 5.5 percent after paying discount
points. They'll borrow more than they owe on the payment-option
ARM and use the money to pay off the $2,000 in debt remaining on
the line of credit.
Why not keep the line of credit, for flexibility?
"I'd guess I'd rather not have temptation in
front of me," Paul Boucher says. "Our basement is done,
our yard is done, and I guess we kind of ..." He pauses, at
a momentary loss for words. "We're fortunate because we have
no credit card debt."
Removing easy credit temptation
Their only debt will be a car loan and a house payment, and that's
the way they like it. "We just said we're going to do cash
all along, as much as we can. The boat and WaveRunners -- we're
just going to have to pay with cash or do without. I really believe
those home equity lines are such a trap."
The Bouchers are lucky -- they're refinancing their
primary mortgage at a lower rate. Not everyone is so fortunate.
"Unfortunately, the window has closed for some
people," LaGiglia says. Specifically, those who got mortgages
at something like 5.5 percent. Rates are so much higher now that
it doesn't make sense for these people to do a cash-out refi. As
LaGiglia says, giving up a lower rate for a higher rate "is
a losing proposition."
Those people will have to keep their current lines
of credit or refinance them into equity loans. "The best thing
you can do," LaGiglia says, "is take out that scratch
pad and look at the options. I don't think refinancing that 5.5
percent first mortgage is the way to go."
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