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Fixed rate home equity loans: Financing the big-ticket purchases.



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Fixed rate home equity loans (HELOANs) are ideally suited for financing big-ticket expenses where a large sum is needed all at once. HELOANs deliver a lump sum when the loan is closed, and repayment begins right away. The loans are popular because the fixed rate adds an element of safety for risk-averse borrowers. The fixed term is typically 15 years but the payments may be amortized over 30 years, leaving a balance to pay off or refinance after 15 years.

Home Equity for Debt Consolidation

HELOANs are especially good for debt consolidation. Most consumer debt carries rates significantly higher than interest rates on fixed rate second mortgages. And making the minimum payment each month does little to retire consumer debt. For example, a $1,000 balance with an 18% rate and a $20 minimum payment translates to a total cost of $2,899 and will take nineteen years to pay off. By contrast, the same monthly payment of $20 on a HELOAN at 8% interest would pay the debt off in 6 years and save $1600 in interest.  By replacing consumer debt with home equity debt, homeowners can reduce monthly payments and/or repay the debts faster.

In addition to higher rates, credit cards may charge annual fees, over-limit fees, late charges, and check-writing fees. Credit card companies may also raise cardholders' rates at almost any time for almost any reason -- for example, cardholders whose credit ratings decline may be subject to a rate increase by the card issuer. And some credit card companies have raised rates for no reason, even for their best customers. Recently one of the largest companies in the U.S. raised the rates for all its customers from 9% to up to 28%. Customers were informed that the only way for them to avoid the increase was to pay the entire balance off immediately and not use the card again. Home equity lenders do not employ 'bait and switch' tactics--the rate and payment do not change.

And finally, home equity loan interest may be tax deductable--making this financing solution an even better deal. Homeowners should check with a tax advisor before taking out a HELOAN if the potential tax break is important to them.

Home Equity Loans for Investment

Home equity loans can be great vehicles for investors. For example, those who want to purchase rental property but don't want to pay a high rate are generally required to put at least 20% down and sometimes up to 35% down. Investors who don't want to clean out their bank accounts to snap up a great deal may be able to finance the down payment with a home equity loan on their residence.

Home Equity Loans for Extraordinary Expenses

Sometimes unexpected events like medical catastrophes trigger the need for a large amount of cash quickly. A fixed-rate home equity loan can meet this need quickly, and repayment is predictable. Borrowers who need a lower payment can opt for interest-only provisions or amortize a 15-year loan over 30 years.

Disadvantages:  HELOANs can be great debt consolidation tools, but there are pitfalls. There are two ways to reduce the cost of borrowing: lowering the rate and repaying the loan faster. A homeowner might get a better rate with a home equity loan, but if debt that could have been repaid in a couple of years is stretched out over fifteen, the total interest expense will almost certainly be more. And most financial planners recommend that short-term assets be financed with short-term debt. For example, a typical auto loan takes 60 months (5 years) to pay off, which is less than the useful life of most vehicles. But roll that loan into a 15-year second mortgage and borrowers could easily end up paying for that vehicle long after it goes to "car heaven." And finally, homeowners who consolidate debt must be willing to change their behavior. Studies show that many borrowers who consolidate their debts also continue to overspend; they end up burning their home equity and falling deeper in debt than before.

Advantages: Correctly used, fixed rate home equity loans are great debt consolidation tools, saving interest expense, lowering payments, accelerating debt payoffs, and perhaps even furnishing an extra tax deduction. For investors, home equity financing allows them to take action and jump on investment opportunities that might otherwise be unavailable, and for those who face a catastrophe, the equity in a home can pay for medical treatments or fend off a family crisis. Because it's secured by a property, home equity financing is one of the cheapest options for homeowners who need money. 

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