Cook’s Corner: Why Refinance? Why are Foreclosures so Cheap? How do Home Equity Loans Work?
Why should I refinance my home?
Here are a few of the reasons people refinance:
- To lock in a lower interest rate for the future, when rates will probably rise. Experts keep predicting rates will rise again and return, to 5% and above. They’ve been wrong for several years, which means the odds are getting better they will be right next time. A lower rate reduces your monthly payment as well as the amount of interest you will owe the lender over the life of your loan by tens of thousand of dollars.
- To lower monthly payments. By getting a lower rate and/or using some accumulated equity to pay down the balance of the loan and by extended the term of the loan, borrowers can lower monthly payments,
- To avoid a higher rate for an adjustable rate mortgage. ARMs usually have a deadline where their initial low-interest rate ends and they then reset at a higher adjustable rate determined by factors like the prime rate. Borrowers nearing their reset date can often lock in a lower rate for a fixed rate loan so that they need not worry about unexpectedly high rates.
- To take out cash for major expenses like remodeling, buying a second home, investing for retirement, or paying a child’s college tuition. However, homeowners who are converting their equity into cash by refinancing should be careful not to use their mortgage as a “piggy bank.” Many borrowers who took out too much equity during the housing boom found themselves “underwater”: with the bubble burst and home values plunged. Many lost their homes to foreclosure.
- To change from one type of a loan to another (such as an adjustable rate loan to a fixed rate loan), or take cash out of their equity to pay for big expenses like remodeling, healthcare costs, buying a second home, retirement or higher education costs.
Why are foreclosures so cheap?
Foreclosures are homes taken over by lenders after their owners defaulted on their loans. In some states the homes are auctioned off by local sheriffs, in others they are returned to the lenders who hold their mortgages and sold on local real estate markets.
Foreclosures, also known as “distressed” properties, are sold at less than other homes because lenders want to get them off their books. Because of this, they are usually sold “as is.” Foreclosures might be abandoned for a number of months before they are re-sold. Today foreclosure discounts vary greatly by market. In some cities where foreclosures are still frequent, like Pittsburgh and Milwaukee, the discount can be as high as 60%. Nationally, in June, the median sales price of a distressed property was 43% lower than the median price of a normal home, according to RealtyTrac.
How does a home equity line of credit work?
A home equity loan is a loan where the collateral is the equity in your home. Equity is the difference between the value of your home minus the amount you may still owe on the mortgage. A home worth $150,000 where the owner still owes $45,000 on the mortgage has $105,000 worth of equity. Home equity lines of credit (or HELOCs) work like a credit card. You have a maximum amount you can borrow, and you access that amount as you need it. The lender replenishes your maximum as you pay it off.