For long-time homeowners, home equity can be a great way to tap into the value of your home to help pay for things like home renovations, debt consolidation, or even college tuition. child.
A home equity loan or line of credit (HELOC) might be the first thing that comes to mind if you’re looking for ways to turn some of the equity in your home into cash – after all, “home equity”. home equity” is there in the name of these types of loans. But right now, experts say there’s a better way for most people to use their home equity: cash refinancing.
No matter when or how you use the equity in your home to get extra cash, it’s important to remember that you’re essentially borrowing money against your home, which is used as collateral with this type of loan. This means that if you don’t repay the amount you borrow, you could lose your home.
Here’s what you need to know about home equity loans and why a cash refinance might be your best bet right now:
What is a home equity line of credit (HELOC)?
Home equity lines of credit (HELOC) are revolving lines of credit, like credit cards. They are backed by your house and traditionally operate on a 30 year model with a 10 year drawdown period and 20 year repayment period. You can spend up to the amount of your line of credit during the drawdown period, and then you’ll have 20 years to pay back whatever you spend (plus interest).
What is a home equity loan?
Home equity loans work like traditional loans. You’ll receive a lump sum of money up front, then make monthly installments to pay off your loan (plus interest). You can use your home loan funds for whatever you want.
The average interest rate on a home equity line of credit is currently around 4.68%, and fixed rate home loans are well into the 5s, depending on the term of the loan, according to Greg McBrideChief Financial Analyst at Bankrate.com.
What is a cash refinance?
A cash mortgage refinance involves paying off your mortgage by getting a new one that is larger than the one you currently have. You will be paid for the difference. At that time, you will have extra money and a new mortgage, which you will pay off over time as you would with the original, under the terms of the new loan.
If your house is worth $250,000 and you owe $100,000 on the mortgage, you have $150,000 of equity. With a cash-out refinance, you could get a new mortgage for $200,000, which is $100,000 more than you owe on the original mortgage. Subtract $12,000 in closing costs for the new mortgage and you’ll pocket $88,000.
Why Home Equity Loans Don’t Make Sense Right Now
Mortgage interest rates are currently lower than home equity loan or HELOC rates. So you may be able to withdraw the equity in your home and reduce the interest rate on your regular monthly payments at the same time. Experts say it’s a smart move since the amount you’ll save on interest is much less with a new mortgage – what you get when you refinance – than with a home equity loan or (HELOC).
“If your current mortgage rate is 3.5%, you’re not going to go out and take out a home equity line of credit for 4.5%, when instead you can refinance your first mortgage and bring that rate down to maybe two and a half percent,” says McBride.
After falling below 3% at the end of 2020, mortgage rates are slowly rising, but remain well below what they were a year ago before the pandemic. At the start of March, the average 15-year fixed mortgage rate – a good loan that many use when refinancing – was still below 3.5%. Compared to the average rate of 4% that this type of loan experienced in July 2019, this remains a very low rate.
Using McBride’s example of rates and the cash-out refinance breakdown above, here’s exactly how much you’d save on interest by doing a cash-out refinance instead of taking out a home loan on top of your original mortgage:
|Main||Interest rate||Interest paid|
|Home Equity Loan||$25,000||4.5%||$9,424.70|
In total, in addition to the combined principal payments of $125,000, you would pay a total of $48,615.03 in interest by adding a home equity loan to your current mortgage. Now let’s say your home is worth $250,000 – $150,000 more than you own using the example above. Take out the closing costs of refinancing a new $200,000 mortgage worth 6%, or $12,000, and you’ll still pocket $88,000.
|New mortgage capital||Interest rate||Interest paid|
|Refinancing by withdrawal||$200,000||2.5%||$40,044.12|
Going the cash-out refinance route would save you $8,570.91 in interest compared to adding a home equity loan to your current mortgage. And aside from the rate advantage that comes with a refinance, home equity loans and HELOCs are harder to get right now than a refinance, McBride says.
What you need to know before refinancing
Before refinancing, you should consider a few factors. More importantly, you should know that refinancing has a cost, at least until you recoup your loss. You get a new mortgage to replace the old one, and that will come with new closing costs — 3-6% of the total value of the new mortgage. Another thing to keep in mind is the importance of refinancing in the shorter term, if possible, so as not to extend the time you pay a mortgage and the interest that comes with it.
You will want to have an idea of your credit score before trying to refinance. If your credit score has dropped since you got your current mortgage, you might not qualify for a refinance at all.
As a benchmark, it makes sense to refinance if you can get a new interest rate a full percentage point lower than your current rate, says Darrin Q. English, development loan officer at Quontic. So a move from 3.5% to 2.5% would be a good decision using this baseline.
Consider your “recovery time”. For example, if you refinance and save $100 per month, and it costs you $2,000 to refinance, you will recoup and start saving from that refinance in 20 months.
“If you can recoup the cost of that refinance within two years, then absolutely [do it]», says the English. But if the cost of your refinance takes you outside of a two-year period and “you don’t have the necessary monthly savings, then you probably want to stay put,” says English.
Know your options: HELOC, home equity loan or cash refinance
While a cash refinance makes the most sense in terms of today’s rates, it’s not the only option. Home equity loans and home equity lines of credit (HELOCs) are common ways for homeowners to tap into the equity in their home for things like home renovations, debt consolidation, or even paying expenses. schooling of a child.
|Refinancing by withdrawal||Home Equity Loan||HELOC|
|What is that||A new mortgage that replaces your current mortgage||Traditional loan that uses your home as collateral||Revolving line of credit secured by your home|
|Length||Same terms as mortgages — usually 15 or 30 years||Varies depending on the amount of your loan; usually 10-30 years||Traditionally working on a 30-year model with a 20-year drawdown period and 10-year repayment period|