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Ready to ditch your home equity loan?

Posted by  on Dec 17, 2012
 

Plenty of homeowners have a bit of a debt hangover from the heady days of the real estate boom. While some homeowners opted for a home equity line of credit when their home equity spiked, others used a home equity loan to purchase their home and avoid private mortgage insurance (PMI). These "80-10-10" loans were popular for awhile because borrowers could make a down payment of 10 percent and finance the rest of their home purchase with two mortgages, skipping PMI payments altogether. But when housing values tumbled, many lenders froze those home equity lines of credit, still requiring the balance used by homeowners to be repaid. If you have a home equity loan or line of credit and want to eliminate it, you have several options:

Home equity loan options

  • Pay it off. If you have the cash to spare, you can simply pay off the loan. Make sure there's no prepayment penalty before you eliminate the loan, however.
  • Refinance the home equity loan. Depending on your loan terms, you may want to refinance your home equity loan into a new loan. Current mortgage rates are so low that you may want to lock in a fixed-rate repayment plan instead of an adjustable-rate mortgage.
  • Refinance your home. Another choice is to refinance your home equity loan and your first mortgage together so that you have one payment each month. Use a refinance calculator to compare mortgage rates for each loan separately and together to see which payment plan works best.

Home refinance challenges

If you choose to refinance your home equity loan, you will have to overcome a few challenges.

  • Equity challenge. Even though home values have stabilized and begun to rise in many housing markets, your home may not be worth what it was at its peak. Most conventional lenders will only loan a maximum loan-to-value of 95 percent and many require you to have at least 10 percent or more in home equity before you can qualify for a mortgage refinance.
  • Mortgage insurance issue. If you refinance and have less than 20 percent in home equity, you will need to pay PMI even if you aren't paying it now. PMI will add to the cost of your financing, so be sure to calculate whether the refinance still makes sense.
  • Credit issues. Mortgage brokers have stricter standards than they did at the height of the housing boom, so check your credit score before you apply. Most lenders require a score of 640 and above to qualify for a mortgage loan.
  • Costs to refinance. Refinancing will cost you money for an appraisal, lender fees, and closing costs. So be sure to consider those costs in your calculations.

Eliminating your home equity loan is a worthy goal, but be sure you consider this move in the context of your overall financial plan including contributing to a retirement fund and having a solid emergency fund.

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