I recently had a call from a client who stated that he received an offer that sounded so good that he couldn’t believe it. He wanted my opinion as to whether he should pursue the deal or not. Basically, the deal dealt with refinancing his home using a home equity loan.
The client currently owes approximately $50,000 and has about 10 years left on a 5 percent mortgage. Currently, the house is worth approximately $200,000 to $250,000. The client was approached by his bank to refinance the home using a home equity loan and was quoted a rate of 2.5 percent on the home equity loan. The client told me it seemed like a no-brainer that he should refinance because he would be substantially cutting his payments down. The question he had for me was, what was he missing?
I love the fact that my client didn’t rush into anything and wanted to get a second opinion before he signed on the dotted line. All too often people hear about a deal and rush into something before they get all the facts. Taking a step back and looking at the details is something that always works in your favor.
In looking at the situation with my client, I told him first, he would need to factor into the equation what the fees were. When it comes to things like refinancing or transferring charge card debt, people forget about what fees are involved. Therefore, one of the first factors you should consider in any refinancing or transferring of debt is fees.
The next factor, particularly when you’re dealing with home equity loans, is the interest rate. Is it fixed, is it adjustable, or is it a gimmick rate? The fixed-rate home equity loan, which is unusual, will remain the same throughout the term of the loan. An adjustable rate mortgage is one that periodically adjusts based upon the changing interest rate environment. Some adjustable rate loans will have no cap, which means that there is no limit as to how much the interest rate could rise. On the other hand, some adjustable rate home equity loans will have a cap which limits how high the rate could increase. Obviously, home equity loans without a cap are more risky than home equity loans with a cap. The third type of loan rate is a gimmick rate. You see this quite often with charge cards in the fact that they will give you a low rate, but unlike an adjustable rate mortgage or a home equity loan where they adjust based upon changing conditions, a gimmick rate is going to give you a lower rate for a period of time and then automatically adjust upwards.
Obviously, in analyzing whether to accept an offer, whether it’s a refinance or using an adjustable home equity loan or a transfer balance on a charge card, knowing how your interest rate can be affected over time is important.
Lastly, the final factor to consider is a home equity loan. Since a home equity loan is considered a line of credit, it is somewhat different than a traditional mortgage. in With a traditional mortgage, typically once you get the mortgage, that’s it. The mortgage company cannot rescind it based upon changing circumstances. That is not the case with home equity loans. Many people unexpectedly found that out a few years ago when they received notices from their bank saying their home equity loan was due. The problem that many people found was that since the value of their home had dropped so much, they no longer had equity. Therefore, the bank, under the terms of the loan, had the right to call in the loan, which many did. This is something that anyone who gets a home equity loan must consider.
In my client’s situation, he found that after he looked at the three factors explained above, it did make sense for him to refinance using a home equity loan. In his particular situation, he is going to continue to make the same payment he’s making today; consequently, with the lower interest rates, he will be able to cut a few years off the back end of his mortgage. This is not necessarily a strategy that will work for everyone.
The bottom line, if you see a deal about transferring your charge card balance or refinancing your home, whether it’s via a mortgage or a home equity loan, be like my client; don’t immediately sign on the bottom line. Ask the right questions, understand the product and then, and only then, make the decision that best suits your particular situation.
One last note, always remember if someone is trying to pressure you into making a move, that is generally a good sign that you ought to walk away.
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