Are you considering refinancing?
Your home is more than somewhere to sleep, eat and keep your things. It's also more than just an investment. Your home can also provide you with a great source of readily available cash. You can use that cash for emergencies, repairs or upgrades. You could access your home equity by refinancing your mortgage. Alternatively, however, you can take out a home equity loan.
Otherwise, if you already have a home equity loan, you may have considered refinancing it. There are many reasons why you might want to refinance your home equity loan. For example, you may want to consolidate your debt. Alternatively, you may want to make some improvements around the house.
You may even have a desire to refinance your loan so that it has a lower interest rate. Yet other homeowners may simply want an infusion of cash. In these cases, yes—it's possible to refinance a home equity loan. Refinancing involves paying off your old mortgage for a new mortgage. Ideally, you'll acquire the new mortgage at a lower interest rate.
With a home equity loan, however, you'll get cash in exchange for the value that you built up in equity on the initial loan. In fact, you can walk away with cash with both a home equity loan and refinancing. If you plan to live in your home for more than a year, refinancing might serve as a better option. With refinancing, you'll pay a lower interest rate, and—in turn—you'll pay lower monthly payments.
Can you refinance a home equity loan?
So far, refinancing your home equity loan most likely sounds like a good idea. If so, it helps to have a FICO score of at least 680. You'll also want a credit score of about 700 or higher. Furthermore, you want to have a low debt-to-income (DTI) ratio.
Finally, you'll need to consider how much equity you've earned in your home. Some lenders allow you to convert more equity into cash compared to others. Typically, however, you'll need to leave a certain amount of equity in your property.
If you're like many homeowners, you're probably interested in cash-out refinancing. This kind of loan encompasses taking out a new first mortgage instead of having both your old mortgage and a new one. You'll end up with two loans with a home equity loan. With a home equity loan, you're still accessing your equity.
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However, as you can see, cash-out refinancing has some advantages over a home equity loan. Firstly, you'll have lower interest rates. Also, you'll only have one payment. You won't have to make payments on both your primary and secondary mortgages.
Your home and equity loans
Usually, a home equity loan has a lower interest rate compared to an unsecured personal loan. You'd secure this kind of loan using your property. At the same time, if you fail to pay your home equity loan, the lender can foreclose. Together, there are two kinds of home equity loans. With a traditional home equity loan, you'd borrow a lump sum. However, you can also access your equity with a home equity line of credit (HELOC)—more on those in a moment.
If you need a considerable sum of money for a specific reason, a home equity loan might meet your needs. Again, you may want to make a home improvement. Alternatively, you may want access to a cash reserve. Furthermore, you may need access to this reserve over time instead of all at once. In that case, a HELOC may serve as a better option.
Is a second mortgage the same as an equity loan?
A traditional home equity loan is one and the same as a second mortgage. For instance, imagine that you have a primary mortgage. Now, you've taken out a loan against the equity you've earned in your home. In the event of a default, the first mortgage will take precedent over the second one. In other words, the first lender will collect any foreclosure proceeds to satisfy your debt.
Once the first lender has recouped their funds, any remaining money will go to the second lender. In short, the second lender is assuming a higher amount of risk. For this reason, a home equity loan most often accompanies a higher interest rate. Still, a home equity loan typically has a fixed interest rate. However, some home equity loans have an adjustable interest rate.
HELOCs, on the other hand, usually have an adjustable interest rate. For this kind of instrument, the lender will calculate the annual percentage rate for your revolving line of credit based on the interest rate of the loan. Meanwhile, the annual percentage rate for a traditional loan typically includes the cost of initiating the loan.
A home equity loan may serve as a good option in a couple of instances. For instance, you may have enough money to pay off your debt. You may also want a lower interest rate. In these cases, a home equity loan is a good idea. Alternatively, however, you might need access to your funds over time. You may also want to make more than one major purchase in the future. In that case, a HELOC may better serve your needs.
Refinancing versus home equity—which is better?
You may wonder whether it's better to secure a new home equity loan or refinance. Well, that depends on your circumstances. Imagine that you took out your original mortgage ten years ago. At that time, you received a 5% interest rate for a 30-year mortgage.
Fast forward to now. Today, you can access a mortgage with an interest rate of 3.5%. That mere one and a half points can knock hundreds of dollars a month off of your monthly mortgage payment. What's more, you can save even more on the long-term cost of financing your home. In this instance, refinancing would give you an advantage.
Understanding home equity loan refinancing
There are two kinds of mortgage refinancing—rate-and-term and cash-out loans. With rate-and-term financing, money does not change hands, with—of course—the exception of the closing costs of the new loan and paying off the old loan. With cash-out refinancing, however, you're turning over part of the equity in your home as cash. In turn, you'll emerge from the deal with a new loan as well as a check for cash.
In most cases, you'll most likely pay 2% to 3% of the loan amount for closing costs. In some areas, you may also have to pay taxes. Again, cash-out refinancing works well for individuals who plan to stay in their homes for a year or more. Yet, a rate-and-term refinance loan may serve the needs of other homeowners. With this kind of refinancing option, you can recover your closing costs in about 18 months by paying a lower interest rate.
You may not plan to stay in your home for much longer. In this case, refinancing may not serve your needs. As an alternative, you might want to opt for a home equity loan. With a home equity loan, you'll pay less in closing costs.
What is a HELOC?
Finally, your third option is a HELOC. A home equity line of credit is a different way to access the equity in your home. It works much like a home equity loan. Still, it's a bit different. Instead, you'll receive a revolving account for the first portion of the term.
Imagine that you have a 30-year HELOC. Usually, the lender will establish a draw period of the first ten years. During this time, you can withdraw up to a limited approved amount. You'll also only have to make a minimum payment during the draw period. Still, you can pay back funds when you desire. After repaying funds, you can also reuse them for other projects or purposes if desired.
Watch out for extra expenses!
With a HELOC, however, you may have to pay transaction fees. For instance, you may have to pay a fee for every withdrawal. Alternatively, you may have to pay an inactivity fee if you don't use your revolving credit during the draw period.
Otherwise, you'd usually only pay interest for what you've borrowed during the draw period. Once the draw period ends, however, you'll no longer have a revolving line of credit. At that point, you'll continue to make payments on the loan. Now, you'll start to pay back the principal plus interest.
Prepping for refinancing
If you're thinking about refinancing, there are a few things that you'll want to consider. Whether you want to refinance or secure a home equity loan, your ability to do so will hinge on a couple of things.
Firstly, you'll need to consider your credit score. For instance, you may have a lower credit score compared to when you first purchased your home. If so, you might want to reconsider altering your mortgage. Most likely, you'll end up paying more in interest.
If you're not sure of your credit score, you'll want to check it with the three credit bureaus. You'll also want to talk about refinancing with a potential lender. Your lender can tell you how your credit score might affect your interest rate. This point is especially important if it's not 740 or higher.
You also have to resubmit personal information, such as your proof of income. You might also have to pay many of the same closing costs as you did with your original mortgage. You may even need to have your home appraised once again. In some cases, however, a lender might waive these fees. Accordingly, it's always important to ask.
Making a decision
In the end, you can find great value in a home equity loan or refinancing. It can help you to turn your home equity into cash. Here, you'll need to figure out if either one of these solutions will meet your needs. For instance, you'll need to start with figuring out how much equity you have available in your home.
You'll also need to think about how you'll use the loan proceeds. You must also think about how long you'll stay in your home. After you've made these decisions, it might prove easier to figure out which option is the best for your situation.
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