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.

Tags: credit-score, heloc, home-equity-loan, sub-prime

[tag]Home equity loan[/tag]

You should bear in mind that you will still be in debt: you will be in a home equity loan debt although you will be free of your credit card debt.
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If you really can’t afford the monthly payment for your $10,000 [tag]credit card debt[/tag], getting a home equity loan to replace it may be justifiable because there are some advantages:
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(a) home equity loan interest rates are lower than credit card interest rates. So you will be using a cheaper debt (home equity loan) to retire a more expensive debt (credit card debt)
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(b) home equity loan interest rates are fixed, and therefore you are free from the risk of unexpected interest rate hike. The monthly repayment instalment is also fixed, thus making it easier for you to plan your cash flows
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(c) the longer the home equity loan period, the lower the monthly repayment instalment. Therefore you can choose a loan period that gives you a low monthly repayment instalment that you are comfortable with. But the trade-off is that the longer the period, the more cumulative loan interest you will pay.
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(d) the interest you pay on the home equity loan is [tag]tax deductible[/tag], whereas your credit card interest is not.
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But do you have the cash to pay for the costs of taking out a home equity loan? You should find a trustworthy lender to determine exactly how much cash you have to cough up to cover the costs of taking out the home equity loan.

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Reducing your credit card limit

If you do replace your credit card debt with a home equity loan, don’t start spending on your credit card again without discipline to build up another beyond-your-means credit card debt. Don’t let the home equity loan make you feel rich.
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Cutting up your credit card and paying for everything by cash is the best discipline, but it may not be practical for you. If you find it difficult to muster self-discipline to curb your credit card spending, you may have your credit card limit reduced to prevent you from overspending. But the resultant drawback is that this will affect your [tag]credit score[/tag] negatively.
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The [tag]FICO[/tag] formula, created by Fair Isaac Corp., likes a nice, wide gap between any balances and the limits on your credit cards. In other words, it likes a low utilization rate on your credit card limits. Lowering your credit limit would reduce that gap and could have a negative impact on your score. (Credit scores, in case you don’t know, are three-digit numbers that lenders use to help gauge your creditworthiness. The FICO is the leading credit score system.)
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For example, if your credit card limit is $8,000 and your credit card debt is $2,000, your utilization rate is 25% (2000 � 8000 � 100% = 25%). If you reduce your credit card limit to $4,000 and your credit card debt remains at $2,000, your utilization rate rises to 50% (2000 � 4000 � 100% = 50%), ie the gap is reduced. This high ratio may be interpreted to mean that you are living closer to the edge.
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If your credit scores are good, you needn’t worry about lenders balking because you have “too much” available credit. If your scores aren’t good, you don’t want to imperil them further by shutting down or reducing your credit lines.
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You have two other possible alternatives to raise the cash you need to pay off your credit card debt, viz. life insurance loan and personal loan.

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[tag]Life insurance loan[/tag]

If you have life insurance policies, you may borrow against the accumulated cash value at relatively low interest rates. Essentially, you are borrowing from your own savings. Interest rates may be fixed or variable depending on the policy.
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Life insurance loans can be a convenient way to borrow money, especially if the interest rate is low. These loans do not have to be repaid, but keep in mind that the outstanding balance will be deducted from the death benefit the beneficiary will receive when you die. It is important that you at least pay the interest as it comes due, since interest will continue to compound on the interest owed on the loan.
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CAUTION!: If you use the cash value in your insurance policy to pay the interest on a life insurance loan, you may use up all of your cash value, which can cause your policy to lapse.

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[tag]Personal loan[/tag]

There are many different types of personal loans (or [tag]consumer loans[/tag]) that you may be able to get if you are unable to take advantage of a home equity loan or a life insurance loan discussed above. They may be secured or unsecured.
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You may consider taking an [tag]unsecured personal loan[/tag]. Since you are a home owner, in the eyes of the lender you are solvent, ie your home ownership implies that you have the ability to meet your financial obligations on time.
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Your home ownership also implies that in case you cannot afford the monthly payments and the lender has to resort to legal means to recover his money, there are more probabilities he will be able to get enough money from your assets to recover the amount owed and any legal fees he might incur.
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You will be charged a fixed interest rate on your unsecured personal loan. Your monthly repayment instalments will also be fixed. You may choose a loan period that gives you a low monthly repayment intalment that you are comfortable with. Of course the longer the loan period, the lower the monthly repayment instalment, but you will pay more interest in total.
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Personal loans are the least favorable way to borrow money, since they typically carry very high interest rates.
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The interest charges on personal loans are not tax deductible.

Tags: consumer-loans, credit-card-debt, credit-score, fico, home-equity-loan, life-insurance-loan, Personal loan, tax-deductible, unsecured-personal-loan