Borrowing Basics: Home Equity Loans vs. Cash Out Refinancing
You’ve probably heard that owning a home is a smart investment – but you don’t always have to wait to sell your home to see the returns. You may be able to use the equity in your home right now to borrow large amounts of money for major expenses like home improvements, automobiles, vacations, college tuition or weddings. You may also be able to consolidate your existing debt – like credit cards or student loans – at a lower interest rate.
As a homeowner, you have two main borrowing options: home equity loans and cash out refinancing. The option you choose largely depends on your situation and your goals. For instance, do you need money quickly, or are you mainly looking to reduce your monthly payments?
Before you make any decisions, know what’s involved with each option and the differences between them.
Think of a home equity loan like a second mortgage – although typically smaller than a primary mortgage – that comes in two varieties:
- With a traditional home equity loan, you can borrow a large lump sum of cash and then repay the amount in monthly installments at a fixed interest rate, usually over 10 to 15 years. The interest rate may be higher, though, than a fixed rate home mortgage.
- A home equity line of credit (HELOC) offers a bit more flexibility. It functions like a credit card, but features a lower, variable interest rate. You can draw cash as you need it from a HELOC, and you only pay interest on the amount you borrow.
These home equity borrowing options may work well for you if today’s interest rates are either the same as or lower than your current mortgage interest rate. Home equity loans also tend to result in cash quickly: Lenders can typically approve and fund home equity loans faster than they can refinance your mortgage. As an added bonus, the interest on your home equity loan may be tax deductible, so be sure to consult a tax expert for advice.
Cash out refinancing allows you to get extra cash by obtaining a new loan for a balance larger than the one on your existing mortgage. You can then use the cash for anything from home improvements to college tuition. In the end, you will have one new mortgage that covers both your primary home loan and the loan for the additional money.
You may find this option attractive if you’re looking for a considerably large sum of money and a lower mortgage interest rate. If rates are lower than what you pay now by one percent or more, you could notice a positive difference in your monthly cash flow.
Refinancing may also make sense if you want to repay your mortgage over a shorter period of time or if you currently have an adjustable rate mortgage and anticipate interest rates rising. Switching to a fixed rate mortgage may give you more stability at a lower rate.
You also have the ability to refinance your current mortgage without the cash out option – enabling you to take advantage of lower interest rates without increasing your debt.
So which choice should you go with? Everything comes back to your short-term needs and long-term goals. If you have questions about your borrowing options or you would like to talk with an experienced loan consultant, call us at (800) 210-8849.