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A person asked me a question, and quite frankly I am stumped! They have the opportunity to lower refi their home and lower their interest rate by about .75% with no closing costs. They would be replacing a conventional mortgage for a fixed rate home equity loan.

Are their any caveats or pitfalls for doing such?

The home equity loan would be the only loan on the property and therefore in first position.

Given the comments, here is the advertisement from the bank: enter image description here

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    Are you sure it's a fixed rate Home Equity? It would be very unusual for a that to be cheaper than a regular fixed rate mortgage – Hilmar Apr 22 '15 at 13:20
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Given today's interest rate environment, i.e. A sub 2% 10 year treasury, the rate makes perfect sense. And it would stand to reason that a 7 year offer would be lower than what the friends had for their 30 year mortgage.

If the bank is reputable, and this deal has no closing costs or hidden fees, it would be a shame to pass it up for the fact that it seems too good to be true.

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    A $100K 7-year mortgage/home equity loan at 2.75% has a monthly payment of $1300 or so. The conventional mortgage at 3.50% (0,75% higher as per the OP's statement) has a monthly payment of about $450. Thus, cash flow might be something to look at before jumping onto the refinancing bandwagon. – Dilip Sarwate Apr 22 '15 at 17:47
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    Good analysis, the person was seeing a 50% increase in payment, however it is not as much of a concern. – Pete B. Apr 22 '15 at 17:49
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    And thus the posting for a friend problem. I guess I assumed Pete's friend got the payment details, and knew the 7 year term might produce a higher payment. – JoeTaxpayer Apr 22 '15 at 17:51
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There are several reasons not to do this in general, though each case is different.

If this is a Home Equity Loan, not a HELOC, and has a fixed rate, then it's not necessarily a bad idea, though it does come with a set of relevant concerns.

The major one I've found is that Home Equity Loans usually have an early payoff penalty. Not a big deal if you're not planning to pay it off early, but very relevant if you are (and this presumably includes selling the house - check the terms of the note carefully.) They also tend to have shorter payoff terms - make sure you're comparing apples to apples here in terms of rates.

If it's a HELOC, then it's quite a bit more risky.

Traditional HELOCs are usually not fixed rate loans. While it may be possible to get a fixed-rate HELOC, it doesn't really make sense that it would be lower interest than a mortgage - unless it's identical to a mortgage. The ability to re-borrow on it at a later date and the usual repayment schedule aren't consistent with lower interest. Because of this, even mortgage sites don't recommend you use a HELOC this way.

There are "Hybrid" HELOCs which have the option of a fixed rate for a portion of the HELOC, but that rate tends to be higher than the variable rate (just like with an ARM vs. fixed rate mortgage).

Now, of course, if your friend (or whoever asked you this) is in a special situation - like he/she still owes most of the cost of the house, but is moving in two or three years, and wants to just cut payments now - a variable-rate option might work (since they'll be paying mostly interest for now and will lose some of the risk by planning to sell before the rates can go too high). However, there's still risk there - risk of another crash or the house not being able to be sold for one reason or another.

  • A border line -1. A HELOC is different than a Home Equity loan. The later is a fixed amount and time period. Note that the discussion is not about a HELOC. – Pete B. Apr 22 '15 at 16:46
  • @PeteBelford Okay, I've separated the two - not sure why some of the articles I read conflated the two when there is a significant difference. – Joe Apr 22 '15 at 16:52
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    Nice work, please see the advertisement, added to the original question, to confirm what I have said. – Pete B. Apr 22 '15 at 16:54
  • Joe - are you planning another edit? As it stands, you don't address the facts as Pete stated, only doubt them. – JoeTaxpayer Apr 22 '15 at 17:22
  • @JoeTaxpayer The first half of the answer is still about HELOC- I wanted to leave that in, as given the number of times I found the two conflated on the internet, potential future visitors might want to know about the difference also. The fourth and fifth paragraph address Pete's case. – Joe Apr 22 '15 at 17:26

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