Since home buying is probably the biggest purchase and the most significant asset for most Americans, the mortgage lenders have some creative ways to help borrowers tap into their home equity by either completing a cash-out refinance or taking out a home equity line of credit (HELOC). Both of these options will give you the ability to turn your home equity into cash so that you can achieve specific goals, such as to consolidate debt or to improve the overall financial situation.
Cash-out refinancing is a form of mortgage refinancing that gives a borrower the ability to refinance the current mortgage for much more than he currently owes, to receive some extra funds. This represents a fix-rate loan, generally for 15, 20, or 30 years, and it’s offering a relatively low-interest rate.
Currently, the average national rate for a 30-year fixed mortgage is about 4.26%.
What’s different with cash-out refinance is that you’re withdrawing a portion of your home equity in a lump sum. You will get to pay a bit higher interest rates for this type of mortgage refinancing because you are increasing the amount of the loan.
The advantages of cash-out refinancing:
- Lower your current mortgage interest rate
- Capitalize on a lower total rate
- You’ll only have one loan and payment
- The interest charged on cash-out refinance may be tax-deductible
- Your 1st mortgage is reset, which would potentially add some extra years to the term until it’s paid off
- You have to borrow the complete amount at once, and then to begin paying it off each month
- The closing process may be lengthy, and closing costs may be high (you can choose a no-closing cost option which bundles closing cost into a higher interest rate)
Home Equity Line of Credit (HELOC)
A Home equity line of credit is a second mortgage secured by using your home as collateral. A HELOC does not payout in a lump sum. It’s more flexible because of its functions as a revolving line of credit with the adjustable interest rate. It also allows you to borrow only how much you need and when you need it (you can tap into a HELOC which can be available for up to several years.
With an equity line of credit, interest does not begin to accrue until you draw down the line. It’s typically based on a 25 to a 30-year term. The borrower will only have to pay down the interest monthly during the first ten years, while the final 15 or 20 years are fully amortizing. Some of the equity lines of credit can allow you to convert the specific amount of loan balance to a fixed-rate loan, prior to the end of your draw period. You can later opt to replace your HELOC with a fixed-rate second mortgage or maybe to bundle your HELOC’s balance into the existing first mortgage loan by refinancing.
The average interest rate for a home equity line of credit nationwide is around 5.61%.
The advantages of a HELOC:
- The interest rate is generally low
- It’s quicker and easier to secure due to fewer lending restrictions
- You can draw the money when you need it and pay no interest
- The interest rate is adjustable. This means it can rise at any time, resulting in higher payments due
What would be the best choice for you?
You need to carefully consider many important factors before committing to one of these two financing options. The right choice depends on your circumstances, the state of your existing first mortgage, the amount of financing needed, your income and cash flow, and also your tolerance for risk. Home equity lines of credit tend to be the simplest and easiest to obtain since they aren’t subject to truth-in-lending regulations or the Dodd-Frank rules. A HELOC is the simplest, but the sources are limited, and they sometimes tend to be expensive. On the other hand, the cash-out refinance the most complicated to get but can be a perfect option if you don’t already have a great mortgage because, in most cases, they can be the least costly option in the long run.
Both cash-out refinance, and a home equity line of credit have fees associated with them. With cash-out refinancing, prices are upfront in the form of the loan closing cost. With the home equity line of credit, several types of fees may be periodically charged, like the inactivity fee for non-usage or the annual fee. The best way for you to reduce these fees is to try to shop around and compare lenders.
Whichever loan you decide is the best fit for you, make sure that you have a clear purpose for that equity that you’re going to pull out of your home. If you are wise with the funding, then your home can be an excellent source of financing for your life’s big projects.
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