But many homeowners don’t know the difference, and so can end up choosing an option that isn’t the most financially feasible. However, this doesn’t have to happen to you when you know the difference between a home equity loan and refinancing your home.
The Home Equity Loan
Your home equity can be calculated by subtracting your current mortgage’s outstanding balance from your home’s property value. The resulting number is how much can be used as collateral for your second mortgage. The home equity loan is secured by the ownership of your home.
A home equity loan can be defined as a loan on top of your current mortgage loan. Essentially, you will be making payments each month on two mortgages. The good thing about the home equity loan is that the power to choose is in your hands. You can choose the repayment terms, which can help you in the future by reducing your monthly payments.
When considering a home equity loan, the purpose for doing so is important. Making large purchases of items of a frivolous nature are not recommended as a good reason for getting a home equity loan. Any payments missed when this option is chosen will be good candidates for foreclosure.
The Refinance
Refinancing differs from the home equity loan in a few ways. First, you don’t have two loans to carry; with a refinance, you are replacing your current mortgage with a new mortgage. This also means that you will be starting from the beginning with making your mortgage payments.
Getting a refinance can mean being able to lock in at low rates if you can catch them at the right time.
In the case of a cash-out refinance, you can end up with a larger mortgage, but take advantage of getting cash as well. If you have already done the cash-out refinance, you may not be able to refinance your property in this way again unless you have more than twenty percent equity in your home.
When considering a traditional or cash-out refinance, doing so for the purpose of consolidating credit card debt is not recommended. This is because doing so can actually lengthen the amount of time it takes you to pay off your credit card debt.
The Best Conditions for Each Option
A home equity loan makes the most sense when you already have a good interest rate and plan to stay in your home for the long haul. As well this option suits those who don’t anticipate borrowing a lot of money, as refinancing does come with its set of significant closing costs, which could end up equaling what you borrow.
Refinancing is best if you are able to get a rate that’s much lower than what you’re currently paying.
Another reason to refinance is if you can’t handle the financial burden of two monthly payments on two mortgages. A refinance is also probably not for you if you have already been paying your mortgage for a number of years, as this option requires that you start all over again with a brand new mortgage.
Understanding your options is the first step to making an educated decision about the route you want to take with your home. The second step is understanding the risks. Doing research about your options online can be much less expensive than hiring a professional to help you.
However, you should also be wary of everything you see online, especially if it’s been posted by an individual and not a company. Everyone’s situation will be different, and so the solutions suggested by others may not work as well for your circumstances.
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Guest author Sam Dickson writes on a variety of topics related to the mortgage industry. He has developed a free online home mortgage calculator and helpful advice to homeowners looking to maximize their dollars.