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IF you’re like millions of other American homeowners who have been paying down a mortgage and watching property values rise, you've probably built up quite a bit of equity. Tapping into it is usually quick and easy, and, even in the face of interest rate hikes, home equity loans can still make sense. "When interest rates come up and there's a healthy housing market, a lot of people who are house-rich and cash-poor look at home equity loans," says Vassilis Lekkas, a Freddie Mac economist. According to Freddie Mac, properties refinanced in 2000 experienced a median appreciation in equity of 27 percent, compared to 11 percent in 1999. But before you decide to cash in, look at the options. You have three basic choices, and here are the pros and cons for each. 1. Refinanced MortgagePros: By refinancing your existing mortgage, including some or all of the equity you've built up, you can take the cash and use it to make other investments or payoff higher-interest debt. If your original mortgage's interest rate is higher than current rates, a lower fixed rate could reduce your payments, even if you take out the equity. If you have an adjustable rate mortgage (ARM) that has been going up, anew fixed-rate mortgage could take away worries over future increases.
Cons: If your original mortgage's interest rate is lower than current interest rates, your monthly payments probably will increase. You may be able to offset this by extending the term, but by the time you pay points (each point is 1 percent of the financed amount), other loan charges and escrow fees, it may not be worth it. The generally accepted rule is that refinancing makes the most sense when the new interest rate is at least 2 percent lower than the original rate. 2. Home Equity LoanPros: With a home equity loan, you don't touch your original mortgage, but borrow only against your equity. This makes sense when current interest rates are higher than the rate on your existing mortgage, since you'll be paying the increased rate only on the amount you borrow. The loan process is simpler, and there are usually less fees involved than with a complete refinance.
Cons: Home equity loans typically have higher interest rates than a refinanced mortgage. There also may be large balloon payments or prepayment penalties associated with them. 3. Home Equity Lines of CreditPros: A "HELOC" usually has a quick approval process, few if any up-front costs and works much like a credit card, allowing you to dip into your equity whenever you need it. You don't get charged interest until you actually take out cash. Because there are no prepayment penalties, it's a good way to borrow short term for improvement projects or appliance purchases.
Cons: HELOCs are almost always adjustable-rate loans, and those periodic Increases can get expensive. Interest rates are generally less than credit cards, but because it works so much like a credit card you may be tempted to use your HELOC like plastic for everyday shopping. There may be a fee for each advance. No matter which home equity-tapping option you choose, most of the Interest should be deductible. Check with a tax professional to be certain. By some estimates, this tax savings could bring the effective interest rate on a 9.5 percent loan down to 5 percent.
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