With a credit score of 550, I probably won’t be able to get a mortgage to buy a second house costing $20,000. My existing house that I paid for with cash in full has an estimated market value of $25,000. I’m contemplating taking out a home equity loan on my existing house to pay for the second house. Any suggestions? My monthly income is $1,200.




Since your credit score is 550, you fall in the “sub-prime” category. Being in the sub-prime category, you’ll have a hard time with getting a favorable interest rate. (By the way, I presume you’ve already checked your credit score and you’re satisfied that your credit history is correct).

As of November 9, 2007 the national average APR (annual percentage rate) for borrowers with FICO score 620-639 is 13.207% for 15-year fixed rate home equity loan, and 14.294% for HELOC. Since your credit score is below 620, you’d probably have to pay at least these rates.

If you take out a 15-year home equity loan of $20,000 at the fixed rate of 13.207%, your monthly payment will be about $256, or close to 21% of your montly income. You will not have to pay PMI (private mortgage insurance) since your LTV (loan-to-value) ratio is exactly 80%, ie 80% x $25,000 (market value) = $20,000. Your home equity loan interest is tax deductible.

It’s generally not advisable to use HELOC as a long term loan because HELOC is on adjustable rates that fluctuate from time to time according to market conditions, and so is more risky, and makes your monthly payment planning uncertain.

Instead of using your existing home to take out a home equity loan, you may consider taking out a mortgage on the second home you want to buy. For credit scores 500-579, the national average APR for a 15-year fixed-rate mortgage is 10.994% as of November 9, 2007. This is cheaper than taking out a home equity loan on your existing home. For a 15-year fixed-rate mortage of $20,000 at 10.994%, your monthly payment will be about $227, or about 19% of your monthly income. But your maximum loan amount will be $16,000 (= 80% x $20,000) only, if you want to avoid PMI. The lender’s fees and other closing costs will further reduce the net amount of loan you’ll receive. Your mortgage interest will be tax deductible.

You’ll have to shop around to find the financing option that suits you best.

Credit score is not the only criterion

Although credit scores are important, they are not the only deciding factor that lenders use when approving a mortgage. The FICO is one of the factors, not the only one.

Your low credit score can be balanced by other “offsetting factors”, eg an overall low debt-to-income ratio, large cash reserves, or large down payment. Your low credit score is not an insurmountable obstacle. Therefore it’s important that you don’t assume your low credit score will prevent you from getting a mortgage. Don’t prejudge your situation.

Currently I have a 30-year fixed-rate mortgage of $148,000 at 6.75%. My monthly payment inclusive of property tax and home insurance premium is $1,276. I’m also paying $122 each month for PMI. My home’s appraised value is $183,600. When my loan is no longer subjected to PMI, I want to refinance my mortgage to take out $10,000 to $15,000. What will my monthly payment be like?

To get your answer, you need to first get some realistic data such as interest rates, points and closing costs. The following link gives you an excellent source of free quotes from established lenders, and you are not obligated to take out any loans from them:

Get Free Quotes for your analysis

(1) Your existing monthly loan payment
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Although you are paying 1,276 a month, your monthly loan payment is actually 960. The balance of 316 (= 1,276 less 960) comprises your property tax and home insurance premium.

(2) Your loan-to-value ratio
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Right now your loan-to-value is 80.6% (= 148,000 / 183,600 x 100%).

In 12 months’ time, your loan will be reduced by 11,519, ie 960 x 12, to 136,480 (= 148,000 less 11,519). Your then loan-to-value will be about 74% (= 136,480 / 183,600 x 100%), assuming your home’s appraised value will remain unchanged.

(3) How much cash will you be able to take out
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If you don’t want to pay PMI, your refinanced mortgage cannot exceed 80% of your appraised value, ie 80% x 183,600 = 146,880.

Let’s assume that you’ll refinance your mortgage one year later when your loan is reduced to 136,480, as shown in paragraph (2) above. The maximum amount of cash you can take out will be your refinanced mortgage (ie 146,880) less your loan balance in 12 months’ time (ie 136,480):

146,880 - 136,480 = 10,400.

(4) What will your new monthly payment be
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Set out below are some of free quotes I receive from a lender:

Rate	Payment	APR	Lender fees & points	Other closing costs	Govt taxes & fees	Total costs
5.500%	$834	5.895%	$6,203	$1,260	$597	$8,060
5.625%	$846	5.966%	$5,335	$1,260	$597	$7,192
5.750%	$857	6.043%	$4,573	$1,260	$597	$6,430
6.250%	$904	6.367%	$1,789	$1,260	$597	$3,646
6.500%	$928	6.539%	$594	$1,260	$597	$2,451
6.750%	$953	6.750%	$-415	$1,260	$597	$1,442

Note:

(i) Other closing costs include fees of closing attorney/agent, appraiser, title insurance, and credit reporting.

(ii) Total costs = Lender fees & points + Other closing costs + Govt taxes & fees

(iii) Homeowner’s insurance and property taxes are omitted

Assumption

The above free quotes are given based on the following assumptions:

(a) Loan amount = $146,880

(b) Property value =$183,600

(c) Propery type = single

(d) Product = 30 year fixed

(e) Property state = Georgia

(f) Loan purpose = Refinance with cashout

(g) You have no second mortgage/home equity lines

(h) Your current credit rating = excellent

Any of the 6 options in the table above will give you a monthly payment less than your current monthly payment of 960 (see paragraph 1 above).

The 5.500% option gives you the largest cash savings because the monthly payment is the lowest, ie 834. But this option requires the largest cash outlay — the total costs is 8,060. This will reduce your intended cash takeout of 10,400 (see paragraph 3 above) to only 2,340 (= 10,400 less 8,060). This option will thus defeat your purpose.

If you want to maximize your cash takeout, the 6.750% is your option. Your monthly payment savings will be minimal because your new monthly payment (953) is almost equal to your current monthly payment (960) , but your cash takeout will be maximized at 8,543 (= 10,400 - 1,260 - 597). Will this be acceptable to you, since your objective is to take between 10,000 and 15,000 cash out?

Summary

There is no general answer as to what your revised monthly payment will be after you refinance your mortgage. Your lender’s offers will determine your monthly payment, and also whether or not you’ll be able to meet your objective of taking out 10,000 - 15,000 cash.

You must never make your decision based on only qualitative considerations. You must always work out the numbers and analyze them. To get reliable results, you should use realistic data. You should get free quotes from lenders. There are many lenders who are keen to provide you with the relevant information. Try this good resource:

Get Free Low quotes for your analysis

Be sure that these lenders tell you their fees, points, other third parties’ fees, and all other attendant costs. Ask them for their APR (annual percentage rate) because this is the real cost of your loan. Look at the APRs in the table above. Each APR is higher than the corresponding interest rate because APRs take into account your interest costs, the lender’s fees and points. Thus APRs are more accurate measures of your overall loan cost.

Using the data in the table above, it’s clear that you can:

(a) take cash out from refinancing your mortgage, and

(b) keep the monthly payment the same as, or less than, your current monthly payment, and

(c) avoid paying PMI.

The only question remaining is: are you satisfied with less than 10,000 cash takeout?

I’m not applying for a home equity loan yet, and I don’t want to disclose personal information.

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You can explore a wide variety of financial institutions that make home equity loans, such as savings and loan associations, commercial banks, mutual savings banks, mortgage companies, and the bank where you have your checking or savings account.

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Your local newspaper is one source where you can find the lender who offers the most attractively priced loan. Look for the lender’s shoppers guide to mortgage credit. You can find these shoppers guides in many localities. You can use them to identify the lenders with low rates.

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In any case, the way to find the most attractive [tag]home equity loan rates[/tag] and terms is to shop around.

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An effective way to shop around is to get no-obligation, free quotes of individualized loan rates and terms from established lenders. You don’t have to be applying for a loan in order to get these free quotes. These lenders are hungry for your business. Let them compete to impress you with their offers. They are just too happy to give you their best information that includes not only loan interest rates but also points, fees, closing costs, and other relevant information.

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No credit check is needed for getting these free quotes. Only basic, non-intrusive particulars are required, such as your property’s locality and value, the loan amount you need, you contact details, and so on. Lenders need these data to assess your financial situation and quote you more personalized loan rates.

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The most attractively priced home equity loan is not one that charges the lowest interest rate. Your interest rate is only one part of your mortgage loan. There are other costs that lenders charge you, such as points, fees, transaction costs, closing costs etc that may add thousands of dollars to the cost of your loan. Some lenders have different names for these costs.

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If lenders notice that you’re hung up on loan interest rates, they may play to your weakness and offer you low rates to lure you while increasing the other costs mentioned above. From these multiple sources of income, they may reap a return (known as [tag]APR[/tag] or [tag]Annual Percentage Rate[/tag]) higher than the interest rate they charge you.

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What you should be concerned with is your loan’s APR. To lenders, APR is their real profit. To you (the borrower), APR is your real cost. Your home equity loan rate is only one of the components of your loan’s APR.

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When you ask for free quotes, make sure that you’re given not loan interest rates only, but also all the other costs and fees that the lenders will charge. Be sure that they quote their APRs too.

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What we have discussed so far deals with your question on loan interest rates only. Interest rate evaluation is only one part of your loan evaluation.

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Get your no-obligation, free quotes here.

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