Your home has gone up in value, but you also owe
a lot of money on credit cards and other debts. How
can you get money out of your home to pay off your
other debts and avoid bankruptcy?
There are three ways to borrow against your home
as a bankruptcy alternative:
1. Get a home equity loan
With a standard home equity loan the lender
loans you a lump sum of money, and you repay the loan
in equal monthly payments over the term of the loan.
For example, you might get a home equity loan for
$20,000, and pay if off over a two to ten year period
of time. The loan would be secured by your home. If
you already have a mortgage on your home, this home
equity loan would be a second mortgage.
A first mortgage normally has an amortization
period of 15 to 30 years, so you would be paying off
your home equity loan more quickly than you would
pay off a typical mortgage. The longer the term of
the loan, the more you will pay in interest, so to
reduce the interest you pay you should select the
shortest amortization period possible.
Because most home equity loans are second mortgages,
they carry an interest rate higher than a first mortgage,
because the lender is taking more risk.
2. Get a home equity line of credit
A home equity line of credit is similar to
a home equity loan, except there are no fixed terms
of repayment. In a home equity loan you make the same
payment each month, and by the end of the term of
the loan you have paid off the entire balance.
With a home equity line of credit, you may only be
required to pay the interest each month. You can pay
off the entire balance as quickly as you want, and
borrow against it as frequently as you require cash.
For example, if you have sufficient equity in your
house, you could negotiate a $20,000 home equity line
of credit. The line of credit is secured against the
value of your home. If you borrowed $5,000 against
the line of credit, you still have unused borrowing
capacity of $15,000.
The biggest advantage of a home equity line of
credit is that you are only paying interest on
the amount you have actually borrowed ($5,000 in our
example) not the entire amount the lender has agreed
to lend ($20,000 in our example). This keeps your
interest costs as low as possible. In addition, unlike
a home equity loan with a fixed term, you can pay
the loan off as quickly as you have cash available,
which also reduces your interest costs.
The interest charged on a home equity line of credit
is about the same as on a home equity loan with a
fixed term, which is slightly higher than the rate
on a conventional first mortgage.
Beware however, of one significant difference between
a fixed term loan and a line of credit. With a fixed
term home equity line of credit, the interest rate
is fixed or locked in for the term of the loan. It
will never increase or decrease. With a line of credit,
the interest rate is variable, meaning it can increase
or decrease, which will increase or decrease your
cost of borrowing during the term of the loan. If
you are worried that interest rates will increase,
you should consider a fixed rate home equity term
loan instead of a line of credit.
A home equity loan is a great bankruptcy alternative
if your income fluctuates. If you are a commissioned
salesperson who gets a quarterly bonus, you could
use your quarterly bonus to repay your home equity
line of credit, rather than waiting until the end
of the term of a standard home equity loan to pay
3. Cash-out Refinancing
With cash-out refinancing, you get a new mortgage
for more than is owing on your existing mortgage.
The difference is the "cash-out" you get
on the re-financing.
Here's an example. Your house is worth $200,000,
and you currently owe $120,000 on your mortgage. You
get a new mortgage for $150,000. The first $120,000
you receive goes to pay out your old mortgage, leaving
$30,000 remaining, which is the cash you take out
of the deal.
In this example, you could use the $30,000 you receive
to pay off your credit cards or other high interest
rate debt, which is certainly an alternative to bankruptcy
and losing your home.
Cash-out refinancing is different than a home equity
loan because it's not a second mortgage; it's a new
first mortgage, which means you are getting the best
possible interest rate. However, because you are breaking
your first mortgage, you may be required to pay a
penalty for breaking the mortgage, so that cost should
be factored into your analysis of the cash-out refinancing
Of course in our example you have replaced a $120,000
mortgage with a $150,000 mortgage, so your monthly
payments will be higher, or you will be paying longer,
so be sure that you can afford whatever you are borrowing.
Summary of the three ways to borrow against your
home as your bankruptcy alternatives
Borrowing against your home is generally the least
expensive form of borrowing, so whether it's a fixed
term home equity loan, a home equity line
of credit, or cash-out refinancing, but
be sure to consider all options before deciding on
one specific bankruptcy alternative.