People take on home equity loans (second mortgages) for a variety of reasons. One of the most popular reasons is for debt consolidation–they refinance revolving credit cards and pay off personal loans and adjustable rate interest loans to avoid bankruptcy and increase cash flow. Sometimes, a second mortgage provides shorter terms for paying off debt. George Saenz, a tax advisor with Bankrate gives this example in his article “Loan consolidation: Yes!” slickcashloan
Let’s say you have $25,000 in debt you’ve been paying $500 to $600 a month on, and the amount of debt has been the same for a while now. If you refinanced that into a four-year home equity loan at 7.23 percent, your monthly payment would be $601 and you’d get it paid off.
Second mortgages consistently offer lowered interest rates than those of credit cards and unsecured personal loans, resulting in lower monthly payments. The tax deductibility and low interest rates of a home equity loan also make it attractive. The saving from consolidating credit card debt make these fixed rate home equity loans even more luring.
There are two types of home equity loans: home equity installment loans (HEILS) which are generally fixed-rate loans, and home equity lines of credit (HELOCs) which are adjustable rate loans.
The home equity installment loan is a lump-sum loan on which you immediately start paying principal and interest. The adjustable-rate HELOC allows you to draw money as you need it and pay just the interest for several years (the draw period), then pay principal and interest later on during the repayment period. The HELOC will generally give you a lower introductory interest rate than fixed-rate loans, but the rates generally change when the Federal Reserve raises or lowers the federal funds rate. Short-term rates are currently on the rise, which is why so many people are considering converting their adjustable-rate home equity lines of credit for fixed-rate loans.
Fixed rate home equity loans are good for people who know how much they need, which is why they are so popular for debt consolidation. George Saenz says, “I recommend that if you’re refinancing debt, get a home equity loan rather than a home equity line of credit (HELOC).” Fixed rate loans have a stated interest rate that does not change over the life of the loan, whereas the rates on adjustable rate loans are linked to an index and change as the index rate changes. The greatest savings for fixed-rate loans can be seen over time when rates increase, as they are steadily doing now. By locking in a low rate now, you could save you a significant amount of money over the long term. Fixed rates provide a borrower with the stability of always knowing what their rates will be.