For long-term homeowners, home equity can be a great way to leverage the value of your home to pay for things like home improvement, debt consolidation or even college tuition for a child. .
A mortgage or credit line (HELOC) may be the first thing that comes to mind if you are looking for ways to convert some of your home equity into cash – after all, “equity” is right there in the name. of these types of lending. But right now, experts say there is a better way for most people to use their own funds: cash refinancing.
Regardless of when or how you use your equity for extra cash, it is important to remember that you are actually borrowing money from your home, which is used as collateral with this type of loan. This means that if you fail to repay the amount you borrow, you may lose your home.
Here’s what you need to know about home equity lending and why redemption refinancing may be your best bet right now:
What is a Equity Credit Line (HELOC)?
Domestic equity credit lines (HELOCs) are revolving credit lines, like credit cards. They are insured from your home and traditionally work on a 30 year model with a 10 year draw period and a 20 year repayment period. You can spend up to the amount of your credit line during the lottery period and then you will have 20 years to repay what you spend (plus interest).
What is a home equity loan?
Mortgage equity loans work like traditional loans. You will receive a lump sum in advance and then make monthly payments to repay your loan (plus interest). You can use the funds from your mortgage for whatever you want.
The average interest rate on a home equity line is currently around 4.68%, and fixed-rate equity loans are at 5, depending on the duration of the loan, according to Greg McBrideChief Financial Analyst at Bankrate.com.
What is Cash-Out Refinancing?
A cash mortgage refinancing is when you repay your mortgage by getting a new one that is bigger than the one you currently have. You will be paid for the difference. At that point, you will have extra cash and a new mortgage, which you will repay over time as you did with the original one, according to the terms of the new loan.
If your home is worth $ 250,000 and you owe $ 100,000 on the mortgage, you have $ 150,000 in equity. With a redemption refinance, you can get a new mortgage for $ 200,000 – $ 100,000 more than you owe on the original mortgage. Subtract $ 12,000 from the closing cost of the new mortgage and you will save $ 88,000.
Why equity loans do not make sense right now
Mortgage rates are currently lower than mortgage or HELOC rates. So, maybe you can take stock out of your house and at the same time reduce the rate of your regular monthly payments. Experts say this is a smart move, as the amount you save on interest is much lower with a new mortgage – what you get when you refinance – than with a mortgage or (HELOC).
“If your current mortgage rate is three and a half percent, you are not going to go out and enter a housing equity fund for four and a half, when you can instead refinance your first mortgage and reduce that interest rate to maybe a hundred, “says McBride.
After falling below 3% at the end of 2020, mortgage rates are slowly rising, but are still much lower than they were a year before the pandemic. At the beginning of March, the average 15-year fixed mortgage rate — a good loan for many for refinancing — was still below 3.5%. Compared to the average 4% interest rate seen on this type of loan in July 2019, this is still a very low interest rate.
Using McBride’s example of interest rate refinancing and overdraft analysis, see exactly how much you would save on interest on a down payment refinancing instead of taking out a home equity loan in addition to your original mortgage:
|principal||Interest rate||Interest paid|
|Housing Equity Loan||$ 25,000||4.5%||$ 9,424.70|
|Original mortgage||$ 100,000||3.5%||$ 39,190.33|
In total, in addition to the combined capital payments of $ 125,000, you would pay a total of $ 48,615.03 in interest by adding a equity loan to your current mortgage. Now, suppose your home is worth $ 250,000 – $ 150,000 more than you have using the example above. Eliminate refinancing closing costs for a new $ 200,000 mortgage worth 6%, or $ 12,000, and you will continue to earn $ 88,000.
|New mortgage principal||Interest rate||Interest paid|
|Cash-Out Refinancing||$ 200,000||2.5%||$ 40,044.12|
If you follow the redemption refinancing path, you will save $ 8,570.91 in interest compared to adding a mortgage to your current mortgage. And in addition to the interest rate advantage that comes with refinancing, equity loans and HELOCs are more difficult to qualify for right now than refinancing, says McBride.
What you need to know before refinancing
Before refinancing, you need to consider a number of factors. Most importantly, you should be aware that refinancing comes at a cost, at least until you recover. You get a new mortgage to replace your old one and this will be accompanied by a new closing cost – 3 to 6% of the total value of the new mortgage. Another thing to keep in mind is the importance of short-term refinancing, if possible, so as not to prolong the time you pay on a mortgage and the interest that comes with it.
You will want to have a handle on your credit score before attempting to refinance. If your credit score has decreased since you received your current home loan, you may not be eligible for refinancing at all.
As a basis, it makes sense to refinance if you can get a new interest rate that is a full percentage point lower than your current one, he says. Darrin Q. English, a development loan officer at Quontic. Therefore, a jump from 3.5% to 2.5% would be a good move using this baseline.
Think about your “recovery time”. For example, if you refinance and save $ 100 a month and it costs you $ 2,000 to refinance, then you will recover and start saving from this refinancing in 20 months.
“If you can recover the cost of this refinancing in two years, then absolutely [do it]”, Says the Englishman. But if the cost of refinancing leads you out of a two-year period and “you do not have the monthly savings to figure it out, then you probably want to stay put,” says English.
Meet your options: HELOC, Home Equity Loan or Redemption Refinancing
While redemption refinancing makes the most sense when it comes to current interest rates, it’s not the only option. Mortgage and equity (HELOC) credit lines are common ways homeowners can use their own funds for things like home improvement, debt consolidation or even paying for a child’s tuition. .
|Cash-Out Refinancing||Housing Equity Loan||HELOC|
|What is this||A new mortgage that replaces your current mortgage||Traditional loan that uses your home as collateral||Revolving credit line secured by your home|
|Length||Same with mortgage terms – usually 15 or 30 years||They vary depending on how big your loan is. generally 10-30 years||Traditionally work on a 30 year model with a 20 year draw period and a 10 year repayment period|