Thanks to the current housing market, that brought the interest rate to a very low benchmark. It naturally tempts many homeowners to refinance their mortgage to take advantage of the flat interest rate.
But, not all mortgages are equal, and everyone’s financial situations are not the same. Naturally, the homeowner has a lot of issues to deal with: decorating, painting, set roots at residence, and above all use home as a means of investment. When equity is built up in the house, there is a tendency to surfing other ways to benefit from the venture.
Refinancing, despite low rates, might be the right choice all the time. While consolidating and reducing debt is a good reason, refinancing options to procure luxury items such as boats, cars, vacation trips can lead to potential hardship and foreclosure.
However, cash-out refinance, and home equity loans are the two major types of credit used by consumers to access the accumulated value in their home equity by saving money on loan payments, access additional capital, and simplifying debt repayment.
When considering the types of loans, it is essential to compare the benefits. Also, how they work, and the likely drawbacks of each before making a decision.
This piece of content will discuss and give information on the cons and benefits of each and how to determine the right choice for the individual financial situations.
What is Refinancing and Home Equity Loan?
Refinancing is a loan that allows homeowners to convert their existing home equity into cash for other needs while on the other hand, home equity loans allow borrowing of money using home equity as collateral.
Home equity is the value of the property minus the remaining mortgage. It is also referred to as the second mortgage. Both are similar in that they have fixed interest rates, offer lump-sum payments, and require a post-transaction loan-to-value ratio of 90% or less to qualify.
Which of these loans is the best?
Cash-out refinance or Home equity, which one is the best? The decision to choose depends mostly on the preference and financial situation of the consumer.
It will be crucial to seek the advice of a financial advisor when the decision arose to obtain one. The essence is to understand the type of loan that best suit the present condition of the consumer.
Usually, the below factors are to be considered when evaluating loan types;
- The amount to borrow
- Fixed or flexible loan terms
- Home equity amount
- Current mortgage’s interest rate
- Time to repay the loan
The home equity loan can be the best choice only if:
- There’s a need to use the second mortgage without need to pay for mortgage insurance
- Current mortgage rates are higher than the price of the existing mortgage
- When there’s a need to use home value without impacting existing mortgage
Refinancing might be the right choice if;
- A need to consolidate for a lower rate
- To make home improvement
- Having enough equity to borrow
- A decision to keep a single mortgage payment rather than multiple payments
It is imperative to note that it is possible to run the risk of having foreclosure if payments are not made since both types of loans use home equity as collateral.
When faced with a refinance option, the homework to do is to figure out the best deal.
The basic rule of thumb in refinancing is that it is a good option if it is possible to lower the interest rate by a percentage point of 2 or more. Other things to consider are the closing costs and the life of the credit.
Determining the amount of time to pay off the closing price (break-even) and time to stay in the house is also essential. It takes roughly 3-4 years for most people to break-even.
The current type of mortgage must also be put into consideration.
For example, a homeowner with an adjustable mortgage rate may want to switch to a fixed-rate to know what the monthly payment would be. Or better still, change to ARM that provides better features like payment cap or a better starting price.
The length of the loan is another thing to consider. There are adjustments to short term credit to build equity, increase the value of properties (home improvement), or to invest in a college education.
Before the search for a potential refinance, it is vital to go through the fine print on the current mortgage. There is a mortgage that assesses fees and penalties for early pay-off. It is not advisable if the penalties exceed the overall savings.
When deciding on the best refinancing option, it is essential to carefully investigate and juxtapose all options to determine the best option.
Aside from knowing the type of mortgage (variable or fixed), APR (annual-percentage-rate), it is good to consider how long it will take to pay it off.
Short term mortgages most time have a lower rate, higher monthly payment, and vice versa.
Points of origin or commissions (also known as discount rates) are commissions paid to the lender or broker after the transaction is completed. A point is one percent of the total loan amount.
There are no “zero cost” or “zero points” loans, but they are usually more expensive when the lender charges a cap. It is best to determine whether saving a reduced refinancing rate can justify the payment of these points.
Frequently Asked Questions
Which is easier to qualify for?
Cash-out is usually a bit easier to qualify for. It replaces the primary mortgage. Lenders give it a priority since it provides them first position as a creditor.
Is It Better to Take Home Equity Loan or Refinance?
First of all, consider the rate. If after customer lower their price on the first mortgage and take some additional cash out, then consider refinancing. But, if today’s rate is higher than the existing rate, then a home equity loan is better.
Refinancing can be a bit challenging due to the coronavirus outbreak. Lenders are facing high demand for credit and staffing issues. See COVID-19 Financial Resource Guide for the latest information on managing financial stress during this emergency.
How to choose?
The best way to determine what type of home loan is the best is to talk to a personal banker or financial advisor who can evaluate individual needs. When deciding which restructuring is the best, consider speed, cost, prices, and deadlines.
Equity loans are faster, have lower interest rates, but generally have a higher annual-percentage-rate (APR). They are also shorter and more flexible. By considering all the options, the best opportunities will surface out.