Your home is not just your castle. It can be a cash source for home renovations, repairs, college tuition, or an emergency fund. The equity you have built up can be tapped through a mortgage refinance or a home equity loan. What’s the difference and which is better for you?
A mortgage refinance pays off the old loan with a new one with a higher loan amount, usually lower. A home equity loan gives you equity with a different mortgage loan, known as a second mortgage.
Refinancing Your Current Loan
There are two ways to do your mortgage refinance: rate and term refinance and cash out:
- A rate and term refi does not add to your loan amount, and you do not receive cashback. There are closing costs and fees, as with any new loan.
- The cash-out refinance loan gives you some of your equity as cash. You come from the closing table with a new, higher loan and a certified check with some of your equity.
Expect closing costs to be 2-3 percent of your new loan amount. On a refinance, you may need to pay taxes depending on your state and community. It is wise to live in the home for at least another year if you refinance your mortgage. Financial experts advise going with a rate and term refinance if you can recoup your costs in about 18 months with the lower interest rate.
Home Equity Loans
Home equity loans are second mortgages with lower rates than unsecured loans because your property backs them. That is the catch: If you do not pay the second mortgage, the lender can foreclose your home.
There are two types of home equity loans: a regular home equity loan with a lump sum cash payment and a home equity line of credit (HELOC).
A HELOC loan is similar to a credit card that is connected to the equity in your property. During the draw period after you receive the HELOC, you may borrow as much or as little as you wish, for the most part. Some loans require minimum withdrawals.
You may need to pay a fee every time you pull out cash or a fee if you do not use the credit line during the draw period. During the five to 10 year draw period, you only are paying interest on what you borrow. When the draw period is over, your credit line is gone. You begin paying back the loan principal plus interest. Both HELOCs and home equity loans are tax deductible in most cases.
A home equity loan and HELOC are often referred to as second mortgages. You already have your first mortgage, and then you take out another loan against the equity built up in the home. The home equity loan is subordinate to the first mortgage. If you default, the second lender is behind the first lender to collect proceeds from the foreclosure.
Second mortgage loan rates are usually higher because of their higher risk.
Home equity loans usually have a fixed rate, but some are adjustable. HELOCs typically have flexible interest rates based on the Prime Rate or LIBOR Rate.
Refinancing or a Home Equity Loan?
You bought your home 10 years ago and the rates were 5% on a 30-year fixed mortgage. In 2020, you can get a new mortgage at 3.5%. Saving 1.5 points on your new mortgage can cut hundreds of dollars per month from your payment. It also will reduce your interest payments by thousands over the loan term. A mortgage refinance could be your best option.
However, if you already have a 3% rate on your first mortgage but want cash to pay for a new kitchen or deck, a home equity loan could be a perfect choice.
You may opt for a home equity loan with a fixed rate if you like to know precisely your rate and when the loan will be paid in full. If you want a lower initial rate and are comfortable with the rate adjusting in the future, a HELOC could be for you.
The ability to get a mortgage refinance or a home equity loan largely hinges on your credit score. If your score has dropped since you bought your home, refinancing may not work because your interest rate could rise.
Check your credit from the three major credit bureaus before you apply for a mortgage refinance. Talk to your lender if your credit score is not well above 700 to see how it may affect your rate.
Getting a second mortgage requires you to submit documents to show you qualify. A home equity loan and HELOC can have the same closing fees as a first mortgage. Some of the closing costs include an appraisal, attorney fees, title search, and an application fee.
A mortgage refinance and second mortgages can help homeowners turn their equity into cash in hand. To decide the best option for you, think about your available equity, why you want the money, your credit score, and how long you intend to live in the home.
- Refinancing vs. Home Equity Loan: What’s The Difference? Accessed at https://www.investopedia.com/mortgage/heloc/refinancing-vs-home-equity-loan/
- Which Is Better – Cash Out Refinance Or Home Equity Loan? Accessed at https://www.experian.com/blogs/ask-experian/which-is-better-cash-out-refinance-or-home-equity-loan/
- HELOC and Home Equity loans vs. Cash-Out Refinance. Accessed at https://www.forbes.com/advisor/mortgages/heloc-home-equity-loan-vs-cash-out-refinance/