When you own a home, you are not only making an investment in your own future, you are also stuffing money into a giant savings back that is there if you need it. If you’ve owned your own home and lived in for more than a few years, you’ve probably become familiar with terms like “home equity loans” and “refinancing.” Given how low interest rates are right now (and given how badly banks need new business in terms of new lending), these show up a lot in the marketing for banks.
Refinance and take equity out
These two items are somewhat different, but they both have to do with tapping that “savings account” that is your home. If you bought your house back before the crash of 2008, then you paid somewhere a higher percentage than today’s rates even if you had solid credit. Now you can get a loan at an interest rate at historical lows. Even with fees, refinancing could save you a ton of money over the rest of the amortization of your loan.
A home equity loan involves a slightly different sort of scenario. You’re happy with the interest rate on your loan, but your son is about to head off to college, and you haven’t been able to qualify for the low-interest loans that some colleges offer because of your income. So you find out that you could take out a home equity loan for significantly less interest expense than what he would pay if he had a student loan. This is a situation in which this sort of loan would make sense. Let’s take a closer look at the difference between refinance and taking equity out.
A refinance involves finding another lender to give you a new mortgage with more suitable terms and pay off your existing mortgage. In some cases, your existing lender will switch out the mortgage and issue the refinance as well.
A rate and term refinance simply alters your interest rate and the term of the loan. Unless there are some fees due at closing, no money changes hands. A cash-out refinance gives you some of the equity in your house in the form of cash. That’s what you would use to pay for your son’s tuition, or to pay off some high-interest credit card debt, medical bills and other similar expenses.
Before you take on a refinance, though, make sure you know what he closing costs will be. Expect to pay around 1-2% of the loan amount in closing costs, which means that if you are refinancing, plan to stay in the house for at least another year to see savings.
A home equity loan has your property as its security, which is why it generally has a lower interest rate than unsecured credit, either in the form of a loan or credit cards. You can either take out a traditional loan, which means you get a check for an agreed sum and then start paying back that principal with interest over he agreed term. If you take out a home equity line of credit (HELOC), that’s more like a credit card. You have approval to take out a set amount of money, but you don’t have to take it out right away, and you don’t have to take it all at once. You have a set draw period in which you can take out money, and if you do take it out, after the draw period ends, you start paying it back. It’s important to remember that in urban and rural markets you can get as much as 80% of your home’s equity out in a loan, provided your credit meets prime lender requirements.
Both the home equity loan and the HELOC come with closing costs, and the bank will ask your documentation to show that you qualify for it. A home equity loan will usually have a higher interest rate than your initial mortgage. However, be careful about lenders who advertise an introductory rate, because that low rate can spike after the introductory time period (maybe six months or a year), leaving you paying much more.
Equity takeout vs refinance
So how do you choose between equity take out vs refinance? Both have their advantages, and both have their drawbacks. In either case, you’re adding to what you owe on the balance of your home, so be careful, and only take out what you need. The scenarios that make either one ideal are slightly different, but if you have questions about your situation, call one of our refinancing specialists at Amansad Financial to get advice tailored to your needs.