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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
•
Bankrate.com |
Post-bankruptcy lending
Dear Dr. Don,
I have a home that appraises for $125,000 with
equity of $98,000. I am self-employed with a FICO score of 560 and
a 2.5-year-old bankruptcy. I would like to pay off some of my high-interest
rate loans with a home equity loan but am unsure if I would qualify,
and if I do qualify about how much would I or should I qualify for?
Please advise.
Ricky Restructure
Dear Ricky,
You're likely to qualify for a home equity loan or home equity line
of credit, even with your low FICO score and your prior bankruptcy
because a home equity loan is a secured loan backed by your equity
in the property. If you don't pay, they take your home away. Of
course, that's also the downside to refinancing your loans with
secured debt.
The home equity lender would want to limit the loan-to-value
(LTV) of the first and second (home equity) mortgages to less than
the appraised value of your home. The closer you get to 100-percent
LTV, the more risk the lender takes on, resulting in even higher
interest rates on the loan. If we assume a maximum 80-percent LTV,
you'd be able to borrow up to $78,400.
I'm a little concerned that 2.5 years after your bankruptcy discharge
you are in a position where you need to restructure your debt. That
said, using your home's equity to restructure your debt can make
a lot of sense. You'll get a lower interest rate on a secured debt
than you would on an unsecured debt, and you may be able to use
the mortgage interest deduction on your income taxes to reduce the
effective rate of interest by the tax savings.
This strategy works out quite well if you have the
financial discipline to refrain from using the home equity loan
as a method to free up credit card balances and continue credit
card spending.
Tapping your home's equity can make sense, but the
long-term goal is to pay down your mortgage(s). Every time you tap
your home's equity you're using your wealth to pay off your debts.
Keep going to that well and you'll wind up with no equity in your
home and never having developed the ability to live within your
means.
-- Posted: May 20, 2004
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