Credit Tips: Home Refinance for Cash Out or Home Equity Loan?

“Sub-prime [bad credit] mortgage lending rose 60% last year,” said SMR vice president George Yacik, “to $516 billion.” One of the most common reasons for this: debt consolidation. With the new, more complicated and expensive bankruptcy laws in effect and credit card companies doubling their minimum monthly payments, people are looking for other ways to get out from under high-interest debts.Tapping into your home equity is an effective way for you to pay off debt (including credit card debts and high-interest loans) and raise your FICO score. With low credit scores, you will probably be better off getting a home equity loan (second mortgage) rather than refinancing into a bad credit mortgage, especially if you’ve been paying on the mortgage for five years or more, because the interest rates on the new loan will probably be much higher than your current mortgage rates. While the rates you pay on a bad credit 2nd mortgage will be higher than what you pay on your existing mortgage and higher than what a person with good credit would pay, it will probably still be less than your credit card rates. According to Paul Banister, author of 25 Fascinating Facts About Personal Debt, a typical American family today pays about $1,200 annually in credit card interest. And, the average interest rate on credit cards is 18.9 percent.How much equity do you have to cash out on? For a refinance, lenders base how much equity you have on your home’s loan to value (loan to value)–the relationship between the unpaid principal value of your existing mortgage and the property’s appraised value or sales price, whichever is lower. For a 2nd mortgage, it’s based on your home’s combined loan to value (CLTV)–the relationship between the unpaid principal balances of all the mortgages on your property (typically a 1st and 2nd mortgage) and the property’s appraised value or sales price, whichever is lower.Home Equity Installment Loan or Home Equity Line of Credit? A home equity installment loan (HEIL) is generally the best choice for debt consolidation because you’ll be to lock in as low an interest rate as possible and that rate won’t change during the life of the loan. Your payments will also stay the same through the life of the loan. Home equity lines of credit (HELOCs) are typically variable rate loans and are generally better for shorter-term borrowing, or to cover emergencies.