Over at Bankrate.com, The Bankruptcy Advisor was recently faced with this question:
- Can a person with a Chapter 13 bankruptcy get a home equity loan to get rid of the bankruptcy? Do you know of any banks willing to take the risks?
First, for people who don’t know, those under a Chapter 13 bankruptcy are still obligated to pay their debts, but they do so under a three- to five-year court-supervised plan.
Now, here’s something that might surprise readers: Even though you’re on a Chapter 13 bankruptcy plan, you may be a very attractive candidate to a mortgage lender. There are a few issues, however.
First, traditional mortgages may be difficult to obtain; you’ll probably need to find a subprime lender to do your mortgage refinancing.
A subprime lender deals with people who have equity in their homes, but lack good credit. Such lenders look less at credit and more at the equity in your property, along with your capacity to pay the mortgage. They also charge more for their services, while their loans have higher mortgage rates than traditional bank loans.
Second, your home is still an asset of your bankruptcy estate. This means that the trustee assigned to your case will be very interested in making sure that your creditors (and the trustee) receive their share of the equity. The trustee will usually insist that all “proofs of claims” are paid off in full, especially if the loan is done during the first 36 months of your plan.
Third, you need to make sure you can afford the new mortgage. Many subprime lenders want to get a deal done even at the expense of qualifying you for the loan. You’ll need a trustworthy accountant or financial expert to let you know whether you truly qualify for the new loan.
In fact, a second mortgage may be a viable option, but you must make sure you can comfortably afford the payment. Even though the subprime lender will do the deal, it might be better to stay in the Chapter 13 plan than to take on a loan with a very high rate.
In this situation, avoid adjustable-rate mortgages, or ARMs. These are loans with an initial “teaser” interest rate that will adjust after a period of time. If interest rates rise, your monthly payment could increase significantly. The loan broker may try to assure you that your credit will improve after two or three years, and therefore recommend an ARM. This is not always true.
Warning: Be very wary of working with any lender that offers only home equity loans to pay off your creditors. The rate is likely to be exorbitant; it might overextend you and risk your property.
Trustworthy lenders will offer fixed-rate, first-mortgage options as well as home equity (second mortgage) options. The rate will be higher than the rate from a traditional bank mortgage loan, but the reward of getting out of bankruptcy may be worth it.
For years, your house may have been your biggest cash reserve. Taking out a home equity loan and raiding that piggy bank made financial sense because interest rates were low and rising home prices kept replenishing the funds.
Now, though, mortgage rates are up and prices soft, is there any reason to tap your home equity?
Difference in current housing market
Opening a home equity line of credit is no longer a slam dunk for three reasons.
- It’s not cheap money: Even though rates may drop in 2007, in recent years they’ve been increasing At today’s average home equity loan rate of 8.7%, the interest-only monthly payment on a $100,000 HELOC is $72; compare this to $387 when rates hit their lows nearly three years ago.
- You could owe more than you own: Lenders have made it possible to borrow 100% of your home’s value. During the housing boom, for instance, many buyers who were stretching to afford a home financed the down payment with a HELOC. Do that today and if prices fall, your home mortgage loans could add up to more than your house is worth.
- The market may not bail you out: Throughout the boom, homeowners financed lavish upgrades with HELOCs, confident that the run-up in their home value would outstrip the cost of construction. Without that tailwind, you can’t be sure you’ll recoup everything you put into your home. You’re paying nearly 9% to make an investment that’s no sure thing.
What to do
Despite all of this, you may still want to tap your home equity - it’s easy, and interest on as much as $100,000 in debt is typically tax deductible. Just be careful.
And make it the right reason. That includes doing wise renovations, especially if you plan to stay put indefinitely, but not such extensive ones that you own the biggest house on the block.
Don’t be pressured by a lender or mortgage broker. The may argue that by waiting to take out a loan or line of credit, you won’t be able to borrow as much. Sure, if your home’s value is lower, your maximum loan will be smaller, but that’s not necessarily a bad thing.
Finally, shop smartly. You can eliminate rate worries by locking in a fixed payment instead. Rates on old-fashioned home equity loans are actually lower than HELOC rates today - 8.1% on average.
If you prefer the flexibility of a HELOC, take advantage of all the competition among mortgage lenders and check the Web for deals in your area, reports Money Magazine.
You often hear about the Federal Reserve raising or lowering interest rates. But do you really understand how that affects the rates you pay for home equity loans and mortgages — or even credit cards or car loans?
With interest rates, almost everything is relative. With a few exceptions, most rates consumers pay are pegged to other rates, from the Fed’s benchmark target rate for overnight loans from one bank to another to the prime lending rate that banks charge their best customers.
The duration of the loan plays a big role.
According to the San Jose Mercury-News, much of the shorter-term interest you pay is pegged to the most discussed interest rate in the country, the Federal Reserve’s federal funds rate, which is the target interest rate for overnight loans from one bank to another.
The target rate is set during the Fed Open Market Committee’s eight regularly scheduled meetings a year; it is called a “target” because actual rates paid are set by the market. The Fed Funds target rate is currently 5.25 percent, but in late October, the “effective” daily Fed Funds rate fluctuated from 5.23 to 5.26 percent.
The Fed Funds rate is the benchmark banks use to set their “prime lending rate,” the rate they charge their best customers. Usually 3 percent above the Fed Funds rate, the prime rate is important because it is used to set home equity loan rates and credit card rates.
The rate consumers pay is always higher than the prime rate, a difference called “the spread.” The spread occurs because lenders will only loan money to riskier customers if they’re paid extra for that risk — thus the high-interest, higher-risk bad credit mortgage.
The spread is determined in part by the consumer’s credit worthiness and whether the consumer’s loan is secured. Since a bank can repossess your house if you don’t pay your home equity loan, you’ll pay lower rates on such a loan than you would on an unsecured credit card loan — this is especially true if you have bad credit.
“When a loan is unsecured, they can threaten you, they can call you, they can send lawyers after you, but if you don’t have any money to give them, you don’t have any money to give them,” said Keith T. Gumbinger, vice president of HSH Associates, a publishing company that tracks mortgages and other loans.
That said, if you have a much better credit score than your brother, you should also be able to get a loan or credit card with much lower interest payments. Likewise, the U.S. government is more credit worthy than U.S. consumers; and while mortgage rates have a correlation to the rates on 10-year Treasury bonds, mortgage rates are always higher.
It also comes down to basic economics. Supply and demand also play a large role in determining some interest rates, such as those for mortgages and car loans. When demand for something drops off, rates can fall with it.
One reason why mortgage rates are correlated with 10-year notes is that few mortgages last their entire 30-year term: Studies show that most people are likely to move or file for a home mortgage loan refinance within 10 years.
While 91 percent of homeowners deem equity in their primary home as an important financial asset, a survey released last week reveals that many may overlook their home as a useful financial tool. That means there’s a gap in understanding of how to make the best use of a new or existing mortgage loan.
“There’s a prevalent misperception about mortgages that may prevent many Americans from realizing their home’s full financial potential,” said Dan Hanson, managing director of Countrywide Home Loans. “A number of home buyers and homeowners are not factoring in the prominence of a mortgage in their overall financial portfolio and do not manage it as they would any other significant investment.”
Even amid reports of some Americans’ reckless financial habits, the study portrays a more conservative consumer who prefers not to leverage their home’s equity. Six in 10 homeowners would consider tapping equity as a source of funds and 70 percent say they would use money for home improvement loan purposess.
To help home buyers better understand the mortgage process, here are the following tips following tips for finding the right mortgage:
1. Evaluate Earnings. Beyond determining current income, it’s important for home buyers to realistically evaluate earning potential. If an anticipated increase in pay can accommodate possible higher monthly payments, then adjustable-rate mortgages (ARMs) or fixed-period ARMs with lower initial rates may make sense.
2. Be Savvy. It is critical that buyers understand the many details of this significant transaction and are ready to take on the responsibility. Home buyers should learn about financing options relative to their unique situation and honestly assess their ability to manage finances.
3. Estimate Equity. Buyers can factor in how quickly they hope to build equity in their new home. Typically, balances decrease fastest with 15-year fixed-rate mortgages. In addition, conditions such as the rate of appreciation or in home values in buyers’ local market should be factored in. Before you take out a home equity loan or a traditional mortgage, give this careful thought.
4. Factor Fluctuations. Income fluctuations from commission-based jobs or self-employment should be taken into account, as well as other income (e.g., alimony, quarterly dividends, etc.). Home loans with payment option features may allow flexibility to pay the minimum required in leaner months and fully amortized payments or more during periods of increased income-as long as you understand the potential added costs from payments resulting in deferred interest, rising rates, or re-amortizing interest-only mortgages.
Now that you’ve settled on a mortgage, you may want to take a closer look at your monthly mortgage statement. A home mortgage may be leveraged as a strong financial asset. Here are tips for best managing yours:
1. Consider Cash-Out. Cash-out refinancing can leverage equity as a source of funds needed to meet personal and financial goals, including home upgrades that may add to the property’s value in the long run.
2. Investigate Interest. Obtaining a new home loan may be a smart move when you have a current mortgage with an adjustable interest rate that’s on the rise. They may consider loans with a lower rate, a fixed payment, a different loan term or other features that match their current financial situation or long-term goals.
3. Aim for Another Home. Using home equity from a first home can help homeowners springboard into a second home or investment property to significantly build assets.
4. Unlock the HELOC. Homeowners may choose to open a home equity line of credit (HELOC) to tap funds from available equity to be used for multiple purposes, or in an emergency. Interest rates and monthly payments are generally lower than on credit card or installment loans and the interest paid is often tax deductible. Plus, payments are not due until money is accessed, so an unused line of credit can be a safety net for emergencies.
5. Reflect on Reverse Mortgages. Homeowners over 62 years may consider a reverse mortgage to access equity as a source of additional funds. These programs can allow seniors to remain in their homes for as long as they wish, while receiving tax-free loan proceeds. Typically, the final amount owed does not exceed the appraised market value at time of loan maturity.
If you’ve racked up a lot of of credit card debt — to the point that it has become difficult to make the minimum monthly payments — should you consider the use of home equity to bail yourself out? What are the tax consequences if you refinance your mortgage to utilize your equity to pay down our debts?
According to the finance columnist in the Monterey County Herald, if you utilize your home equity to consolidate debt, you may be able to wipe out those multiple nagging credit card payments, simplify your finances and lower your monthly debt expenses.
In most cases you can deduct the mortgage interest payment, which you can’t do with the interest you pay on car loans, credit cards, and private or personal loans.
There are several ways to convert the equity you have accumulated in your home to cash, including mortgage refinancing.
You may also be able to quickly tap into your equity by obtaining a 2nd mortgage or a home equity line of credit.
By refinancing, you are effectively turning the value of your home into working capital to consolidate your debts and improve bad credit. You are left with a single payment to your bank or your mortgage company that could offer better terms and a lower interest rate than your credit card obligations and other debts.
This type of mortgage loan often is referred to as a cash-out refinance or “cash-out refi.” For example, if your home is valued at $300,000 and your balance is $150,000, you might qualify for a 75 percent loan of $225,000 or more. That would allow you to repay the existing $150,000 balance and use the remaining $75,000 to eliminate other obligations.
If you choose the “cash-out” refinance option for consolidating your debts, compare the home equity loan rates and carefully evaluate your new loan terms and the tax consequences of refinancing.
When calculating the terms of your new loan against the outstanding debt obligations that you want to pay off, compare the interest rates.
Credit card interest rates often exceed 10 percent. New credit cards that promise lower interest rates may be offered at teaser rates that go up sharply in a short period of time. For example, if you paid off $25,000 in credit card debt with an APR of 13.99 percent with a cash-out refinanced loan of 7 percent, you would save approximately $1,300 a year.
Depending on how much you want to pull out from a “cash-out” refinancing, you may end up with a bigger loan and a higher monthly payment for which you must qualify. Still, refinancing usually guarantees a lower interest rate than most second or home equity loans.
When you refinance your home to pay off higher interest rate credit card debts, consider that you are trading off short-term obligations for long-term debt. While the payment is less because of the lower mortgage rates, it is amortized over 30 years.
Also, some lenders may be willing to offer you a bigger loan than necessary to pay off your obligations, and you may find yourself deeper in debt. Remember that you cannot borrow your way out of debt. A debt consolidation loan does not necessarily reduce the amount you owe. Instead, it will extend your debt further into the future.
Moreover, it may be tempting to max out your credit cards again after you have paid them off. If your purpose is to get out from under debt, put your credit cards away or at least formulate a disciplined plan for using them, such as paying off any credit charges every month.
The advantage of mortgage debt over other loans is that you cannot deduct interest paid on car loans, credit cards and personal loans. However, your home mortgage interest is only tax deductible if your loan is a secured debt in which you sign an instrument such as a mortgage, deed of trust or land contract.
Also, there is a ceiling of $1 million in mortgage debt when calculating deductible interest. The IRS expects to know how you are using cash-out refinance funds but does not preclude you from using the proceeds to pay off other debts. However, the amount cannot exceed 100 percent of your home’s value.
There are other factors that may affect the deductibility of your mortgage interest, including your original debt, the utilization of your cash-out proceeds and the basis of your home.
Stop, look and check your math before you decide to reduce your debt by tapping the equity in your home through a loan or a home equity line of credit. Weigh all your options. Think through the reasons for consolidating your debt. Is it to bring some discipline to your spending habits, simplify your debts or is it a way to reduce your monthly expenses?
Don’t forget to check with your adviser to determine your eligibility to write off the interest with the new mortgage, as well as the points and other costs that must be paid.
What’s the difference between a home equity loan and a home equity line of credit?
It’s a good, important question. With the help of Don Taylor, a certified financial advisor, allow us to provide the answer:
A home equity loan comes equipped with a fixed interest rate, along with monthly payments sized to pay off the loan over its term. You receive the entire loan amount as a lump sum when you close on it.
In contrast, a home equity line of credit (HELOC), is an adjustable-rate loan, with changes in the interest rate typically tied to changes in the prime rate, which is itself tied to changes in the targeted federal funds rate. The Federal Reserve Board’s Open Market Committee meets eight times per year to discuss the economy and decide whether to change this targeted federal funds rate.
Other differences: Besides possessing a variable interest rate, a HELOC has interest-only payments, at least in the early years of the loan. Some HELOCs are structured to have interest-only payments over the entire loan term, with a balloon payment at the end of the loan. Other HELOCs become self-amortizing loans after an initial period of interest-only payments.
It varies.
Because this is a line of credit, you only borrow what you need, although there may be a minimum draw against the line when you close on the loan. At least for part of the loan term, the credit line is a revolving credit; paying down the balance frees up credit capacity.
The changes in the federal funds rate over the past 2½ years have caused the interest rates on HELOCs to rise above the fixed rate of a home equity loan. Of course, this doesn’t mean that the loan is necessarily the better choice.
What do you plan on doing with the money? How will you manage the monthly payments? Where will interest rates be headed in the future? These are important questions to consider as you weigh various home loan options.
Gregory Truman and Wayne Pruitt didn’t need a real estate agent to sell their Brighton, Massachusetts, condo two years ago.
What they could have used, according to this week’s Boston Globe Magazine, which features the rise and fall of home equity loans in the region as its cover story, was a crystal ball.
The Massachusetts housing market was so hot that Truman, then an assistant professor of information systems at Babson College, and Pruitt, minister of the Union Church in Waban, were able to sell the property in a matter of days for more than $468,000. They promptly upgraded, paying $644,000 for a 1930 Colonial across the border in Brookline.
They got a home loan for $333,700 and secured a home equity line of credit for $140,000 (using $70,000 of that money for the initial purchase of the home and $52,000 to spruce up the place).
Over the next two years, in addition to sanding and painting both inside and out, the couple landscaped the front yard, added stone walls, and put pavers on the driveway. Yet in May of last year, the house suddenly became unaffordable when Truman learned he hadn’t made tenure.
He would be out of a job by August.
Downsizing was in order. Once again acting as their own agents, Truman, 46, and his 56-year-old husband put the house on the market in May of this year for $748,000, hoping to yield a decent return as well as the cost of their improvements.
Yet even after three busy open houses, the only offer they received came in the form of a casual inquiry through a neighbor as to whether they’d go as low as $699,000. Unwilling to take a loss, the couple decided to refinance.
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