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What are 125 percent mortgages?
They are first and second mortgages (equity lines of credit) that total up to 125 percent of your property's market value. Lenders are making them in the hopes that strong property appreciation will last and that the home owner won't need to sell until the debt is paid down. Lenders typically require that borrowers have great credit, which also helps to limit the lenders risk.
While not for everyone, 125 percent mortgages do make sense if the borrower:
- Owns a home with above-average appreciation in a stable neighborhood.
- Is realistic about what the future holds for the local economy (a single-employer town could convert to a ghost town, with no real estate selling, virtually overnight).
- Anticipates keeping the house long enough to whittle down the debt
- Is willing to shop diligently to obtain the lowest interest rates and costs for the loan as this type of financing can easily run 2 to 3 percent over first-mortgage rates.
Be cautioned that the IRS only allows homeowners to deduct interest up to 100 percent of the market value of their property—and yes, they will be watching for 125 percent mortgages!
Is it a good financial idea to keep pulling equity out of your house, keeping it highly mortgaged, so the money can work in other ways?
Some financial planners would like to have you believe so. But just as there's no one stock market investment panacea, handling your home equity is a very individual decision.
Having a large mortgage is a better alternative than paying loads of nondeductible consumer debt. And it's great to have equity to use for financial events like sending a child to college. But it's up to each homeowner to decide how much mortgage debt is enough, based on levels of both financial and psychological risk.
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