Home refinancing or home equity loan: which is better?

If you need money for major expenses, and you have some equity in your home, one option for you is to refinance your home as a means to borrow the needed cash from your mortgage lender. Another option is to take out a home equity loan, which is essentially a consumer loan that is secured by a second mortgage on your house. Which loan is right for your situation?

Home refinance or home equity loan? 3 things to consider

  1. Refinance rate - If your existing mortgage has an interest rate that is lower than today's refinance rates, which are currently hovering around 4.75 percent, then you may be better off keeping your first mortgage in place and getting a home equity loan or line of credit. Conversely, if your existing mortgage has an interest rate that is much higher than the current refinance rate, then you can probably save some money by refinancing the home with a lower rate. You can use a refinancing calculator to compare different loan options and see which is best for your situation.
  2. Monthly cash flow - Some home equity loans only require interest-only payments during the initial months of the loan payback period, unlike most home refinancing loans, which usually require monthly payments that include both interest and principal. If you are on a limited monthly budget, then a home equity loan option which allows interest-only payments may be your best bet, because the monthly payments should be lower than those required on a traditional home refinancing loan. You can use this loan calculator to figure interest-only payments on a given loan, then you can compare them against monthly payments that include both principal and interest.
  3. Timeline of your financial needs - Some major expenses, like college tuition or home remodeling, don't always require a one-time lump sum payment, but rather require ongoing payments over a period of time. A home equity line of credit (HELOC) is ideal for these types of situations, because you can borrow the money as needed, which means you won't have to pay interest on money that you are not using immediately. A HELOC is a type of home equity loan that establishes a line of credit for the borrower to use over a period of time, rather than disbursing the total loan amount to the borrower up front.

Getting either a home equity loan or a "cash-out" home refinancing loan requires that you have significant equity in your house. Your lender will need to appraise the current value of your property to determine the maximum amount of equity that you can borrow.

Due to tighter lending standards and falling home prices which were widely reported for most major areas at the end of 2010, many lenders won't lend more than 80 percent of the appraised value of a property. Therefore it is important that you have an up-to-date appraised value of your home before you determine which type of loan will be best for you.

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