Should I tap my home equity to pay off debt?

By Sabrina Karl

With credit card rates averaging over 16% and the national average for 30-year mortgages running in the mid 4% range, it’s easy to see why homeowners consider tapping home equity to pay off other, costlier debt. But it’s a risky maneuver that shouldn’t be taken lightly, and in some cases, should be avoided altogether.

First, it’s important to realize that paying off credit cards or any other debt with home equity doesn’t actually pay anything off. It only shifts your debt around.

Also, the move is unwise if it’ll drop your home equity below 80%, as you’ll then be hit with expensive private mortgage insurance, which would erase any gains you’re aiming for by refinancing.

You’ll also need to weigh the closing costs you’ll be charged. And recognize that although your expensive debt will move to a significantly lower rate, you’ll now be stretching it over 15 or more years. That means you may actually pay even more for those credit card expenses in the end.

The risk to your home is another serious consideration. Unlike card debt, mortgages and home equity loans are secured with your home as collateral. Default on your mortgage and your house could be in jeopardy. So it’s critical you can reliably afford the new monthly payment, as there is no “minimum payment” fallback on mortgages.

If you can get a lower mortgage rate or shorter term than you currently have, then “cash-out” refinancing to pay off debt can work. But it’s a much more dubious play if your rate or term will increase.

In that case, you’re better off adding a home equity loan that’s dedicated to paying off your expensive debt. Or, just keeping the card debt as is, but with a new vengeance to pay it off as aggressively as you can.

Should I consider an adjustable rate mortgage?

By Sabrina Karl

Anyone who’s ever shopped for a home loan knows they come in two main flavors: fixed rate and adjustable rate mortgages, or ARMs. While traditional 30-year fixed mortgages have long been a homeowner favorite, sometimes an ARM can be a smart move.

Here’s how ARMs work. For a period of years – usually 3, 5, 7 or 10 – the mortgage behaves like a standard fixed-rate loan. You’ll know your rate upfront and it won’t change during that initial period.

After that, your lender can adjust your rate, raising it if national rates have moved higher, or lowering it if rates have dropped. Therein likes the risk with ARMs since no one can reliably predict where rates will move several years in the future.

Of course, you’ll earn a trade-off in exchange for an ARM’s risk. You’ll notice that ARM rates are noticeably lower than 30-year fixed rates. So while they are less predictable over time, you’ll be guaranteed to pay a lower rate for the initial period.

That means an ARM could be a wise choice if you expect to stay in your home less than the number of years in the ARM’s fixed period.

But if your expectations prove wrong and you live in the home long enough to reach your ARM’s adjustable period, you’ll find yourself at the mercy of current market rates. Right now, rates are forecasted to be on an upswing given the Federal Reserve’s movements. But after that, it’s impossible to know where rates will be headed.

In the end, adjustable rate mortgages are an easy choice when you know you won’t live in your home for the long haul. But if you’re like the many homebuyers who aren’t sure how long they’ll stay, a fixed-rate mortgage can be the safer and more penny-wise move.

Is my property tax still deductible? What about mortgage interest?

By Sabrina Karl

Now that the dust has settled on Congress’ new tax plan, let’s look at what the final version means for homeowners.

Starting with the 2018 tax year, the bill changes how much we can deduct for three homeownership expenses: property taxes, mortgage interest and home equity interest.

Property taxes have seen the most press because the change here is significant. Previously, any amount of state and local income taxes was deductible if you itemized deductions, as is common for homeowners. This includes any state income tax, sales taxes and, most importantly here, real estate tax on your primary residence.

In the new plan, however, the allowable deduction for the sum of these taxes is capped at $10,000. So if what you pay for property tax plus your state’s income and sales tax exceeds that amount, the payments above $10,000 are no longer deductible.

The other significant homeowner deduction goes to those with a mortgage or home equity loan, allowing you to deduct interest paid on that debt. In the new bill, mortgages and home equity debt diverge, and your mortgage date will determine how much interest is deductible.

For mortgages originated before Dec. 15, 2017, there’s no change – you can deduct all interest incurred on a debt up to $1 million. But on mortgages taken out Dec. 15, 2017 or later, you can only deduct interest on loan amounts up to $750,000.

The treatment of home equity debt is changing more starkly. Starting with your 2018 taxes, the deduction for interest paid on home equity loans or lines of credit has been eliminated.

It’s important to note that although homeownership deductions are being diminished, the tax bill includes other potentially offsetting changes. So whether your 2018 tax bill increases or decreases will vary widely by region and individual situation.

Should I refinance to pay for home renovations?

By Sabrina Karl

Refinancing a mortgage can be a powerful tool for homeowners. While it’s often done to snag a lower interest rate, another popular reason is turning your home’s equity into cash for home improvements.

Increasing your mortgage balance to renovate or repair your home may be reasonable, or even smart. But not always. You’ll want to consider the trade-offs carefully.

For instance, if refinancing will substantially raise your interest rate, it’s likely not a great move. Also, if you think you’ll sell your home within the next few years, opting for a home equity loan or line of credit will probably serve you better than opening a new mortgage.

You’ll also want to forego refinancing if you don’t have upwards of 20 percent equity in your home. That’s because dropping below this threshold will trigger private mortgage insurance, which is an expense you want to avoid.

Also keep in mind that refinancing isn’t free – you’ll incur some costs for the privilege – and it will involve running a credit check, so will impact your credit score.

But if you expect to keep your home five or more years, and can get a comparable or better APR on your new mortgage, refinancing can be a good source of funding for that home improvement project.

Renovations like major updates or adding to a home’s size are good candidates for tapping home equity since they’ll also increase the value of your home. But cashing in equity for a new roof can also make sense, especially if your only other option is accessing a credit card or other high-interest loan.

In any scenario, the smartest move is researching what the refinancing will cost, how your other funding options and costs compare, and how the new mortgage amount and rate will affect your monthly payments.

Can I prepay my mortgage?

By Sabrina Karl

With mortgages being the longest-lasting debt for most Americans, paying that obligation off early is tempting. And if you consistently have money left over after paying bills each month, investing some of that surplus in your mortgage can indeed be a smart move.

But whether it’s wise given your particular situation has to start with whether your mortgage allows it. Penalties for prepaying your mortgage were fairly common in the 1990s and early 2000s. They’ve since fallen mostly out of favor, but some lenders still impose them, especially for subprime mortgages.

So your first smart move before paying anything beyond your monthly obligation is to check your closing documentation or call your lender to find out if any type of prepayment penalty is stipulated. This is also a good question to ask if you’re currently considering a new mortgage.

Once you’ve held a mortgage five years, the chances are high that you’re safe from prepayment ramifications. That’s because the bulk of prepayment penalties target payoffs during the first two to five years of the loan. Paying off the debt in those early years by selling the home or refinancing can trigger the penalty.

But if you’re beyond the five-year marker, or are your using a lump-sum inheritance or other windfall to pay off some, but not all, of your mortgage, most lenders will take no issue with this prepayment. Similarly, adding a little extra to your payment every month or making 13 mortgage payments a year instead of 12 also typically doesn’t incur any penalties.

Whether mortgage prepayment makes sense for you depends on a variety of factors we’ll address in a future article. But no matter that conclusion, understanding the rules in place on your current mortgage – or a new one you’re considering – is a critical move.