If you’re considering cashing equity out of your home for any reason you might wonder if cash out refinancing or a home equity loan is the best option. There are pros and cons including risks for both options and choosing poorly could cost you thousands of dollars. Here are several tips to help you decide if cash out refinancing or a home equity loan would work best for your situation.
Cashing Out Home Equity Can Be Tricky
In the aftermath of the housing crisis lenders are very leery when it comes to borrowing against home equity, no matter how good your reasons. Part of the risk of borrowing against equity is that you can quickly find yourself underwater regardless of your local market. Another risk with home equity lines is that you’ll borrow more than you need thanks to easy access to your money.
Cash out refinancing generally will not let you borrow more than 75% of your home’s value. Suppose your home is worth 200,000 and you have 65% equity in your home. The most you could borrow is 75 percent of your home’s value which would be $150,000. Since you have 65% equity or $130,000, meaning you owe $70,000, the difference of $60,000 is available for cash out refinancing.
If 75 percent loan-to-value allows you access to sufficient cash for whatever it is you’re borrowing, you’ll have access to lower refinance rates than you would get with home equity loans and lines of credit.
What About Home Equity Loans & Credit Lines?
Most home equity loans (think 2nd mortgage) and lines of credit allow you to borrow up to 80% of your home’s value. The risk here is that you’ll have less of a cushion between yourself and the tide of underwater homeownership.
Home equity loans and lines of credit add a second lien to your home increasing your risk of foreclosure if you’re unable to afford the second mortgage payment every month. On the plus side that 80% loan-to-value limit allows you to get your hands on a greater amount than cash out refinancing. Home equity loan give you a lump of cash at closing whereas equity lines of credit give you access to your cash with a debit card.
Using an equity line works just like a credit card and comes with the risk of over-borrowing because of the ease of access. Interest rates on lines of credit and home equity loans are quite a bit higher than refinancing with cash back, so your cost of borrowing will be significantly higher.
Is cash out refinancing or a home equity line of credit the best option for you? The answer depends on several factors including your acceptable level of financial risk. If you’re borrowing against your equity to make ongoing repairs and you have a level of financial discipline the home equity line of credit allows you to borrow only what you exactly need.
Mortgage Lender Fees Are Important
Especially when you’re refinancing the test of how good of a deal you’re getting comes from how much you’re paying at closing. Overpaying things like the loan origination fee or unnecessary discount points can quickly turn great mortgage rates into a bad deal.
Shopping around from a variety of lenders including community based credit unions comparing both refinance rates AND fees will help you get the best deal.
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