“Got the home equity blues?” by Howard Stanton of Suntrust Mortgage

Got the “Home Equity Blues”?  

Has your Home Equity Loan payment gone through the roof?   Chances are you obtained a Home Equity Loan many months ago, when interest rates were at an enticing 6% or so. Some loans even had introductory “teaser” rates that were below 5%.   Not any more. Almost all Home Equities have interest that is tied to the Prime Rate.   And the Prime Rate has more than doubled from 4.0% in 2003 to 8.25% today.   With most Home Equities at Prime + 1%, homeowners have seen their payments escalate sharply, some with rates approaching 10%. And FYI, the Prime Rate was as high as 20% (!) back in 1981. So, what to do about this mess?

Conventional wisdom says to leave your FIRST mortgage alone, if its rate is locked in somewhere below 6%.   This is generally true …unless you have a large Home Equity at a much higher rate- that may be going even higher. The crucial item to look at is the “blended rate” – i.e. the weighted-average interest rate when you combine your first mortgage rate and your Home Equity interest rate. And, most important to the kitchen-table economist in all of us, will a refinance LOWER my payments?  

Here’s a quick example: 

First Mortgage:   $235,000 @ 5.875% = $1,390/month    (principal and interest)

Home Equity:       $85,000 @ 9.500% =     $673/month    (interest-only)

Total Owed:       $320,000 @ 6.838%* = $2,063/month (*6.838% is your “blended” rate)

So, let’s say you were to refinance everything, including your closing costs. Would it make sense?   A $322,000 mortgage, locked in at 5.99% for five years, would be $1,928/month.   That’s a monthly savings of $135/month and over five years you would save $8,100.   Not bad, huh?   Plus, you would SKIP one monthly mortgage payment. In addition, you would be paying down the principal on the entire amount you owe. Right now, you’re likely paying interest-only (no principal) against that Home Equity.   And you don’t know how high the Prime Rate may go in the future.   

As always, consult with a mortgage professional who can tailor a loan that best fits your situation. It just may be time to get rid of a Prime Rate-based Home Equity