When you consistently make payments on your mortgage, you’re building home equity. Home equity is the share of your home that you actually own. It can be cashed out in a variety of different ways to finance home remodels, debt consolidation, and other big expenses.
But of those different ways, you may be wondering which is better: getting a home equity loan or refinancing? Let’s discuss equity loans vs. refinances and how to decide which one is right for you and your family.
Home Equity Loan
Home equity loans are the most basic way of turning your home equity into cash. They come in two forms: a lump sum or a line of credit.
A traditional fixed-rate lump sum loan allows you to immediately borrow a set amount against your home equity. This is a new loan, separate from your current mortgage. With this option, you’ll receive a single lump sum, which you’ll then make monthly payments on at a fixed rate.
You are only able to borrow a portion of the equity you’ve already built. For example, if you’ve paid off $100,000 over time for a home that cost $250,000, you may access a percentage of that $100,000. In general, lenders will only allow you to borrow up to about 80% of what you’ve built. In this case, that means you can only borrow up to $80,000. You can use this money for whatever expense you choose—but it’s not recommended to rely on it for daily expenses, like groceries.
Home Equity Line of Credit
A home equity line of credit (HELOC) lets you open up a new line of revolving credit against your built-up equity. This option is helpful if you’re uncertain about how much you need and don’t want to over- or undershoot the amount. HELOCs come in two stages:
1. The draw period. Borrowers can use their home equity like a credit card during this phase. You are not required to spend all of the home equity credit allotted to you. The draw period lasts about 10 years on average.
2. The repayment period. This is usually 10-20 years long and involves paying back both the principal and interest each month.
A HELOC may not be the right option if you’re planning on moving before the draw period ends. You may be required to enter the repayment period early if you sell your home, as well as pay a cancellation fee.
Finally, know that HELOCs often have variable interest rates; traditional home equity loans often have fixed interest rates.
When housing interest rates drop, it’s common for homeowners to refinance their mortgages in order to get a better rate and pay less money each month. There are several different methods of refinancing your home—and the method that puts money directly into your hands is called cash-out refinancing.
Refinancing involves replacing your current mortgage with a new one. With a cash-out refinance, you can keep the difference between the two mortgages.
But is now the right time to refinance? Right now, with homeowners hunkering down and housing demand decreasing, home interest rates are incredibly low. If you’ve got good credit, lenders may be willing to offer you a lower interest rate than what you’re currently paying.
What are the similarities?
• Equity loans and refinances both pay immediately—you won’t have to wait to get your money.
• You may use the cash from either option to finance whatever you want: you may pay off high-interest debt, pay for repairs or renovations, or invest.
• Both may involve closing costs or other fees, depending on the lender you choose.
• Neither option lets you borrow 100% of your built-up equity. Most lenders cap what you take out at 70-90% of what you’ve built depending on the option you choose.
What are the differences?
• Refinancing replaces your current mortgage with a new one while home equity loans involve a second payment in addition to your current mortgage.
• Refinance loans generally have lower interest rates, but may require a higher credit score than an equity loan. However, those with low credit scores may still qualify for an FHA loan.
• Different lenders may have different requirements for homeowners to qualify for each option. You may not get the same rates or deals depending on the lender you choose.
• Home equity loans can come as a lump sum or a home equity line of credit (HELOC), which allows you to borrow as much or as little as you need. Cash-out refinances always come as one lump sum.
Equity Loan vs. Refinance: How do I decide which is right for me?
When deciding whether to choose between a home equity loan or refinancing, it’s important to consider (1) what you need the money for and (2) what your current mortgage interest rate is.
If your current interest rate is very high and you have good credit, you may want to explore refinancing to save more money over time. If your credit isn’t high enough to refinance, you can still get the cash you need through a lump-sum loan.
Furthermore, if you’re not sure precisely how much you need, you may consider opening up a HELOC to borrow as you need it. This is great for long-term home renovations and repairs, but not ideal if you’re planning to sell your home right after it’s fixed-up.
If you’re still unsure of your options and want to find out more, reach out to us here at Associates Home Loan. Our experts can help you explore what’s available to you and figure out what’s right for you and your situation. Just click here to contact us.