Be Careful When Incurring Debt Secured By Your Home

MILFORD –– Spurred by spring weather and low interest rates, consumers are refinancing their dream homes to lower monthly mortgage payments or applying for home equity loans to support activities such as home improvement. Despite these good intentions, borrowing can sometimes lead to high-risk credit delinquencies and, ultimately, home foreclosures.

Credit Advisors from Consumer Credit Counseling Service of Southern New England (CCCS) caution homeowners to be familiar with the ramifications associated with taking out loans secured by their homes.

“As a homeowner, I can relate to wanting the best possible mortgage rate as well as to the attraction of putting the equity in my home to work,” explained Steve Bucci, president, CCCS Credit Advisors. “However, refinancing or taking out a home equity loan should not be taken lightly. To put it bluntly, you’re putting your home ‘on the line’ in both instances.”

There is a difference between home refinancing and home equity loans.

According to Freddie Mac, homeowners are carrying an average $140,000 for a single-family mortgage in 2003. Home refinancing is a viable option if a homeowner wants to reduce his or her high interest rate or the term of the loan. It is also sometimes helpful if a person is able to consolidate monthly bills while maintaining the same monthly payment.

The refinancing process requires taking out a new primary mortgage to pay off the old mortgage. Many homeowners who refinance benefit from increased savings from lower interest rates and, subsequently, improve cash flow. Also, people who want to lower a term may pay off their mortgage quicker.

 Home equity loans are separate from primary mortgages. They are second mortgages secured by the equity that has built up in a home. People use this type of loan for such things as to make home improvements, or even to purchase a car or to consolidate bills. Like a primary mortgage payment, home equity loans are tax deductible.

Refinancing or taking out a home equity loan may not be wise for everyone.

It is important to understand the options to know what works best for you.

CCCS offers the following advice:

Is this a good way to consolidate your bills? Though it may sound like a smart move, paying off all your existing debt (particularly credit cards) through a new mortgage or an equity loan could end up costing you more down the line. Consider the term (length) of the new loan and the amount of interest that you will end up paying. Also, if you continue to use your credit cards, you will start to pile up more debt on top of what you have already consolidated, without even noticing it. Remember that payment default here could cost you your home.

Are you paying too much in fees? Comparison shop and work with a reputable lender. Ask about closing and administration fees such as application, processing, underwriting, and document preparation fees. Do not be afraid to ask what service will be rendered for a particular fee. Depending on the lender, some of these fees are negotiable.

Be sure the new interest rate is worth refinancing. Make sure that you plan to stay in your home long enough for the refinancing to be cost effective. For example, if the new interest rate reduces your monthly principal and interest payment by $100 and the closing costs for the new mortgage are $3,600, it will take 36 months to cover the cost of attaining the new mortgage ($3,600/$100=36 months). (This calculation does not take into account the overall interest savings of the new lower rate.)

Will reducing the term increase your payment? Reducing the term on your mortgage will reduce overall interest paid, but it may increase monthly payments. Ask yourself if you are in a financial position now and will continue to be in such a position in the future to handle an increase in the mortgage payment. An option might be to refinance at a lower rate for a similar term. Ask the lender to calculate a payment for 15 years as well as 30 years before you sign.

Do you really want two mortgages? Sometimes it is easier to refinance, combining both the primary mortgage and equity loan together to lower monthly payments. It also eliminates one mortgage.

Establish a spending plan. Create a plan that projects your monthly expenses for the next 12 months that includes income. Obviously, your monthly bills should not exceed your monthly income.

Be prepared to work with the lender. Prompt responses to a lender’s requests will mean a shorter processing time and closing more quickly.

Maintain a paper trail. Keep copies of all documents to and from the lender for your records.

Know a lender’s criteria. A lender’s decision is based on credit worthiness (a risk analysis of the borrower’s income, present debts, property investment, and the credit payment history). Ask how they assess your credit worthiness.

Credit reports are important. Make sure that your credit report accurately reflects your credit history, including repaid credit cards and loans. Inaccurate information may prevent you from qualifying for low-rate loans. To get a copy of your credit report, contact Equifax at 800-685-1111, www.equifax.com; Trans Union at 800-888-4213, www.transunion.com; or Experian at 866-200-6020 or www.experian.com.

CCCS is a community based nonprofit organization and a certified housing counseling agency with offices in Massachusetts, Connecticut, and Rhode Island. Connecticut offices are located in Cromwell, Danbury, East Hartford, Groton, Milford, Norwich, and Stamford. CCCS is accredited by the Council on Accreditation of Services for Families and Children, Inc and is a member of the National Foundation for Credit Counseling (NFCC).

For more information on financial management issues, contact CCCS at 800-208-CCCS (800-208-2227) or visit the website at www.creditcounseling.org.