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Home equity loans, home equity line of credit, and cash-out refinancing as bankruptcy alternatives
   

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Three ways to borrow against your house as a bankruptcy alternative

 
 

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 it off.

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 option.

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.

 

 


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