If you are like many, you have used an increase in the value of your home and the equity you have built up as a source of borrowing through a home equity loan. Home equity loans have been attractive because they are relatively simple, flexible, usually only require payments of monthly interest and provide tax benefits.
However, most home equity loans have adjustable interest rates and your rate may have risen since you borrowed with your home equity loan. In fact, you may now find yourself in a position where the interest rate on your home equity loan is higher than the rate on your mortgage or even higher than the rates currently available on new mortgages.
Consider Consolidating Your Mortgage and Home Equity Loan
As with any review of your mortgage, you should consider rates, types of mortgages, monthly payments, costs of refinancing and how long you plan to stay in your home. With a home equity loan, you also need to remember that usually the required monthly payment is interest only and that the interest rate may change based on changes in overall interest rates.
Here is a calculator to help you compare your current monthly payments with those from a new mortgage that combines the balances of your existing mortgage and home equity loans.
Interest is compounded monthly. This calculator is to be used for estimation purposes only. The financial institution is not responsible for its accuracy and the results are not guaranteed.
As you look at these results, there are be a few things that you will probably notice:
- Even though the interest rates on shorter term fixed rate mortgages may be lower, the monthly payments are probably higher. This is because the amount of principal payment each month is larger. You are paying down the mortgage faster.
- Usually, Arms with shorter term initial rate periods (for example, 1 and 3 years) usually have lower rates and lower monthly payments. This is due to the "yield curve" sloping upward with longer maturities. Longer term loans have higher rates.
Even though shorter term Arms and potentially balloon mortgages offer lower monthly payments, it is important that to understand that rates on Arms can increase after the initial period and that the entire balance of a balloon mortgage comes due at the end of the mortgage period. If you are considering an ARM or balloon mortgage, be sure that you would be able to afford a higher monthly mortgage payment if your rate increases. Here is a calculator that can help you evaluate the impact of increasing mortgage rates.
Other Issues to Consider
- The size of your mortgage payment should only be one part of your mortgage decision making process.
- If "paying off" your mortgage or significantly reducing your total debt level is important, a shorter term fixed rate mortgage with a 20 or 15 year term may be right for you.
- If you plan to live in your home for only a short time (for example, five years or less), you may want to seriously consider an adjustable rate mortgage with an initial rate term that matches your moving plans.
- Balloon mortgages are usually less attractive than a similar term ARM. With a balloon mortgage, you will need to secure a new mortgage at the end of the term subjecting you to not only to changes in rates, but also the costs and process of getting that new mortgage.
- Be sure that you can afford your mortgage payments - both at the time you get it and in the event that you get an ARM and rates have risen when the initial rate period expires.
Choosing the mortgage that is right for you is critical. Consider what you want your mortgage to do for you. Factor in your plans for how long you anticipate needing the mortgage (how long you are going to live in the home) and be sure that you can accept the risk that your monthly payments may rise if you choose an adjustable rate or balloon mortgage.