A lower interest rate and monthly payment on
your home equity loan can free up cash for other
uses, or make your debt more manageable. Interest
rates move in cycles, so the best time to refinance
is when rates drop.
"Refinancing tends to happen in surges --
in fits and starts," says Bill Hampel, chief
economist for the Credit Union National Association
in Washington, D.C. "Typically, rates should
fall a point or more before you do it."
Refinancing entails closing costs and other fees,
so it's important to know whether lower monthly
payments will offset that cost.
"The smaller the drop in interest, the longer
it's going to take you to recover the cost of
refinancing," says Hampel.
Another factor to consider is how long it will
take you to break even. For example, if refinancing
costs run you $2,500 and your payments are $100
lower each month, it will take you 25 months to
break even.
If you plan to sell your home in a year, refinancing
is not the smart thing to do.
"If you plan to be there a long time, then
it makes sense," says Steve O'Connor, senior
director of residential finance for the Mortgage
Bankers Association of America.
Besides a lower interest rate, two other reasons
to refinance are:
• The opportunity to convert all or a portion
of your equity loan from an adjustable rate to
a fixed-rate installment loan
• To obtain a shorter-term loan to build
new equity more quickly.
When they refinance at a lower rate, some homeowners
take the cash from the equity they've acquired
to pay for a big expense such as a remodeling
project or their kids' college tuition.
Refinancing is also a way to avoid a balloon
payment. If you combine your first mortgage and
home equity loan or credit line, you can get one
fixed-term payment and avoid paying a giant lump
sum that would have been due at the end of the
second mortgage term.
Be aware, though, that refinancing can be a bad
deal for those who are taking out equity to pay
off credit card debt. If you transfer $15,000
in credit cards to a new 30-year first mortgage,
your monthly payments will be lower but it's costing
you more to pay off the revolving credit debt
because of the lengthy term of the loan.
If you can swing it, you're better off taking
10 years to pay off the charge cards because it
will save you 20 years' worth of additional interest.
Another downside of refinancing your equity loan
is the possibility of dealing with a new lender,
perhaps one in another state, who handles the
loan differently. There may be new fees for copies
of documents and other services. And rather than
being able to visit your local banker, you could
end up having to deal with questions and problems
by phone, fax or e-mail.
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