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Last week I wrote a post on Five Cent Nickel on the merits of paying down debts with a HELOC. Some people have turned to it as an option in paying down their high interest debt. I want to be a bit more specific today and discuss what HELOCs and second mortgages are and how people use them.
What is a HELOC?
Home equity line of credit or HELOC is a line of credit based on the equity you've accumulated with your property. Lenders calculate equity based on what your home is worth and what you owe on the mortgage loan.
This specific line of credit can be useful for short-term borrowing. Right now, Bankrate reports that interest rates for HELOCs are around 4.8% – 5.1%. Being low, some people open an account and use it as part of their emergency fund.
There are some disadvantages to having a HELOC. With the real estate market down in some areas, homeowners are seeing their equity dwindle. Some lenders have also reduced or frozen accounts, so it may not be a great fail-safe that people think it is.
How Does a Second Mortgage Work?
Besides obtaining a HELOC, homeowners have used second mortgages. Just as it sounds, a second mortgage loan is another loan on your property in addition to your primary or first mortgage. You can multiple loans on the same property. That's a risky proposition,though, because if you can't make payments on all of the lenders, technically any of them can foreclose on your home.
Some first time homeowners who have a smaller down payment use a second mortgage as a method to avoid mortgage insurance. Existing homeowners sometimes take out a second mortgage to pay off high interest debt. The advantage with this option is that you receive the money in one lump sum and it is typically at a fixed interest rate.
Thoughts on HELOCs and Second Mortgages
Have you used either of them to pay down debt? Have you used a HELOC as an emergency fund? How did it work out for you? I've heard some older Americans are using reverse mortgages, but they have their own pitfalls. What's your take on it?
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