When shopping for a loan to consolidate debt (or for other reasons as well), there are a myriad of options available to a prospective borrower. If you are currently a homeowner with some equity in your property, tapping into that equity and paying a lower interest rate than the interest rate on your credit cards (which can often be well over 20%) is often a very good idea.
Options
Your basic options are whether to 1) refinance your current mortgage into one new larger mortgage or a combined first and second "piggyback" mortgage 2) keep your existing mortgage and take out a new closed-end fixed term second mortgage or 3) keep your existing first mortgage and add a new Home Equity Line Of Credit or "HELOC" as a second mortgage.
If you are paying a low, fixed interest rate on your first mortgage, you may be better off leaving that alone and either taking out a new second mortgage or refinancing an existing second mortgage. There are many factors to consider in deciding between a closed-end second mortgage or a HELOC. Refinancing or originating a second mortgage is almost always cheaper than refinancing your first mortgage, as your settlement costs will be much, much lower. You won't have to deal with taxes or insurance escrows, title insurance policies, many lenders will allow cheaper "drive by appraisals" and you are less likely to incur hefty origination fees or points.
Basic Definitions and Differences Between a Traditional Second Mortgage and a HELOC
Traditional Second Mortgage
A traditional second mortgage stands in second position on the title of your home (behind your first mortgage) and will almost always carry a higher interest rate. The terms of a second mortgage can vary greatly (from five to thirty years), but will almost always need to be an equal or shorter term than that of your first mortgage. These mortgages can be combined with first mortgages (oftentimes for the purpose of avoiding PMI) or "stand alone". They are generally fixed interest rate loans, and may or may not have a balloon payment feature, where the entire balance of the loan is due before the loan is fully amortized. Second mortgages are also referred to as "closed-end" because you cannot borrow more than the maximum original amount, as opposed to HELOCs, which you can draw cash out of the equity in your home. When the loan is closed, you receive all of the cash at once, as opposed to HELOCs, which have a minimum required draw amount, and you can pay down and charge up, much like you would a credit card.
HELOC's
HELOCs are similar to traditional second mortgages only in the sense that they typically hold second position on your home's title. If you don't have a current mortgage on your home, your HELOC will be listed in first position on your home's title and you will probably be able to negotiate a better rate. HELOCs differ in most other ways to traditional second mortgages. They are, for the most part, variable interest rate loans. Like your credit card, their interest rate will fluctuate along with the Prime Rate. The Prime Rate is set by the Federal Reserve and listed daily in the Wall Street Journal. Your HELOC rate will be the index (e.g., Prime) + the margin. Your margin will increase if you have a lower credit score, cannot fully document your income, or leave little if any equity available in your property. The interest rate on HELOCs are calculated daily as opposed to a traditional second mortgage, where the interest rate is calculated monthly. The Prime Rate is currently 8.25% and if you see a HELOC with a lower interest rate, make sure that it is not an introductory or "teaser" rate set to adjust in one to three months.
Benefits of Second Mortgages
Traditional second mortgages are generally better for purchases or refinancing to eliminate Private Mortgage Insurance. Because their interest rates are usually fixed, there is a lot more predictability to your monthly housing budget. They are also better for large expenses, such as tuition, etc., but because you receive all your cash at closing, they lack the flexibility of HELOCs. Expect interest rates to run anywhere from 7% (excellent credit) to 14% (average or below credit).
Benefits of a HELOC
HELOCs can be great tools to utilize in debt consolidation if you are not consolidating all your debt at once or anticipate needing cash advances available for emergency expenses, home improvements, etc. There are a few HELOCs available with fixed interest rates that are a wise option to pursue, but are harder to come across than variable rate loans. HELOCs will usually allow you to use all of the equity remaining in your home (100% CLTV), but they may require a minimum credit score of 660 or 680. The 125% loans you may see advertised are usually fixed-rate closed-end second mortgages available to borrowers with great credit and plenty of disposable income.
Debt Consolidation
One common aspect of second mortgages and HELOCs in relation to debt consolidation is that they are both secured loans. Unlike credit cards, which are unsecured, mortgages (HELOCs included) place a lien on your property and must be paid off when your property is sold or refinanced. And although it is not too common, you can lose your home to foreclosure if you default on your promise to repay these loans. Failing to pay credit cards off can trigger pesky collection phone calls and severely injure your credit rating, but credit card companies cannot lay claim to your home or possessions. If you are careful with your finances though, debt consolidation through either a traditional closed-end second mortgage or a HELOC will almost always save you money in the long run.
Recommended Lenders Online For HELOC's or Second Mortgage Loans - We maintain a list of low rate mortgage lenders and update the list frequently. Try applying with one of our recommended lenders first.
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