Thursday, June 01, 2006


Selling Or Refinancing?

Which is the best option for indebted real estate consumers? Read on ...

When you last went shopping for a mortgage you found yourself facing an array of options, from a six-month ‘open’ to a 10-year ‘closed’ and everything in between. And chances are you did not quite grasp or paid attention to the differences among all those many options, mostly because you never envisioned a time of interest rates increase. Now that the tide is changing, of course, the basic question becomes the most important: which option is the best to minimize mortgage costs?

As markets are progressively cooling off as a direct and proximate result of the monetary policies of the central banks, property owners with financing on a variable scale are facing rising interest costs. This fact calls into question whether it is preferable to sell outright, or if it makes more sense to refinance and stay put. Selling may not necessarily be the easy way out, particularly for those who bought in recent years, when the market was entirely different, and ended up paying premium prices, in several instances over and above asking prices. As real estate markets in many areas are now going through a period of value adjustment and wealth consolidation, it may not be possible to recoup the high prices paid only a few months ago. On the other hand, the good news is that lenders are rolling out a host of inducements to attract new borrowers and to keep existing homeowners from paying off their loans.

One such example is the introduction of a new home-equity loan product with a rate that is fixed for 20 years, and which is typically offered at half a percentage point below the standard rate on regular home-equity lines of credit. Other banks are offering enticements to keep customers who are worried about rising rates from paying off their home-equity lines of credit. These banks seem to target those borrowers who previously paid off their home-equity lines or seemed likely to. And yet, other institutional lenders are beginning a program that gives existing customers the option of continuing to make interest-only payments on their home-equity lines of credit, while setting a fixed rate on some or all of the outstanding balance.

Home-equity lending has boomed in recent years as record numbers of consumers have taken advantage of low rates and rising home values to fund their spending needs, or to pay off high-cost debts. Borrowing against home values added $600 billion to consumers' spending power last year, according to Federal Reserve calculations, with about one-third of that sum coming from home-equity loans and lines of credit. But rising short-term interest rates have put a damper on the rapid ascent of the home-equity market. The value of home-equity lines of credit at commercial banks increased 17 percent in September over the previous year, according to the Federal Reserve. That was well below the 45 percent annual growth rate seen last fall. On a month-to-month basis, home-equity line balances, which totaled $438.7 billion at the end of September, have been basically flat since the end of July [source:].

The surge in home-equity borrowing has been driven mainly by the rising popularity of home-equity lines of credit, which give homeowners the right to borrow up to a certain amount, either all at once or as needed. Home-equity loans provide borrowers with a lump sum and a fixed rate. But rising interest rates have made home-equity lines of credit less attractive than they were as recently as the summer of 2004, when the prime rate was just 4 percent. What's more, the rate difference between a home-equity line of credit and a fixed-rate loan has narrowed, because short-term market rates have risen faster than long-term rates. And as rising rates begin to pinch borrowers' pocketbooks, the number of homeowners paying off their credit lines has increased. In fact, industry sources reveal that the number of borrowers prepaying their credit lines has climbed 50 percent this year compared to the same period in 2005. As a result, some borrowers are opting for more predictability.

Lenders, moreover, have introduced new features that allow borrowers to lock-in the rate on some or all of their credit line. Fixed-rate home-equity loans typically make more sense for borrowers who have a one-time need for cash, such as paying off credit-card debt or consolidating existing auto loans. A home-equity line, on the other hand, can be a better choice for someone who needs the money over time, for example, to pay college tuition fees or fund a long-term remodeling project. That's because borrowers pay interest only on the money they have actually drawn from the line of credit. They also can elect to make interest-only payments during the early years.

In essence, if selling is not a viable option, there are basically four approaches to follow so as to minimize costs in the wake of rising interest rates:

[ ] Home equity lines of credit.

They still make sense for borrowers who do not need cash all at once. Though vulnerable to higher interest rates, the borrower only pays interest on the amount of money actually drawn out.

[ ] Fixed-rate options on home-equity lines.
Allow borrowers to lock-in the rate on some or all of their line of credit. This can provide a hedge against rising rates, while maintaining a borrower’s ability to tap the credit line as needed.

[ ] Home equity loans.
Provide borrowers with a lump sum and a fixed rate. Borrowers are protected against rising interest rates, but must pay interest on the full loan amount even if they spend only a portion of the money.

[ ] Cash-out refinancing.
Allows borrowers to pull out extra cash when refinancing the mortgage. Whether this makes sense depends in part on the rate of the existing mortgage and the cost of refinancing.

Luigi Frascati

As Featured On Ezine Articles Platinum Author

Real Estate Chronicle

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