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  • Comparing a home equity loan vs. refinance: Which is better?

    Homeowners with equity in their home might consider a home equity refinance. What is the difference between a home equity loan and a traditional refinance? What is the best option for you? There are important differences between these two financial tools that should be considered prior to making a refinancing decision. First, let’s cover basic terminology:


    What is Equity?

    Equity is the difference between the fair market value of property and any remaining balance on mortgages or liens against that property. For example, if a home is worth $250,000 and the homeowner still owes $200,000 on their mortgage, the amount of equity in that home would be $50,000.


    Using the equity built up over time in a home purchase is one option for homeowners who require a cash resource. And, depending on your financial track record, you may be able to borrow up to 85 percent of your home equity.


    What is Refinance?

    Refinancing literally means to finance again. It is a method of manipulation of a current mortgage obtain lower rates and/or better terms on an existing mortgage.


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    What does a home equity loan entail?

    A home equity loan allows a borrower to use the equity in his or her home as collateral. The size of the loan will be determined by the amount of value a property has – usually determined by an appraisal. A home equity loan is a lien – or security for a lender – against someone’s home. This reduces the actual amount of equity in your home.


    Home equity loans are often used to finance major expenses like home repairs, emergency expenses, college education, or other life milestones.


    Why use equity money instead of refinancing the property to obtain cash?

    For many people, using home equity is a better choice than a refinance of an existing mortgage. Which is best ultimately depends upon what the purpose is for adjusting a current financial situation and how much cash is needed. Home equity line of credit (HELOC) loans normally have a reasonably low interest rate versus other types of loans making it a potentially cheaper form of financing. HELOC is better if an existing mortgage has a low interest rate.


    One of the smartest ways to use a home equity loan is for homeowners considering a remodel for their existing house — with its already low mortgage rate — rather than buying a bigger home at a higher interest rate.  If a homeowner uses the equity in your home to finance a remodel, and can eventually add more value to your home.


    A refinance of an existing mortgage may be preferred if a large amount of cash is desired, and repayments can be spread out over a longer time. Refinance loans are a good way to obtain a lower rate than exists with an old high rate mortgage.


    Are there risks associated with home equity loans?

    Simply put, yes. Home equity loans are riskier than conventional refinances. But, for the financially responsible and disciplined, risk can be lessened.


    Home equity loans mean you are borrowing against your home. The less equity in your home means less padding if something happens, and your home’s value lessens. Borrowing against your home can also be risky should something happen to your income.


    Using the equity you’ve tapped, in a smart way, is important for eliminating the risk associated with home equity loans.


    Refinancing without a home equity loan carries less risk, especially if a borrower secures a fixed-rate loan. When done appropriately, conventional refinancing allows a homeowner to save money on their monthly mortgage payments, and/or offers better loan terms. Terms of a refinance are transparent from the beginning, so as long as a borrower can meet their financial obligations, the deal should be seamless.


    How do rates and terms compare?

    1. HELOC loans are shorter term and have the advantage of lower rates and no closing costs, which may be several thousand dollars. Refinance loans are longer term, so payments are lower but spread over a much longer time period.
    2. Home equity loans can be set up as either a true line of credit or as a bulk amount of cash out. Lines of credit have variable interest rates, and the homeowner can use it like a credit card for just the cash needed at a particular time, up to their limit. A bulk amount is like an installment loan, with regular same payments over a set time.
    3. Most home equity loans are for 10 to 15 years; refinance loans are a mortgage over 30 years. As a general rule of thumb, the longer the loan the more interest will paid, which can make them more expensive. Shorter loans may have higher monthly payments associated with them.
    4. Refinance mortgage rates are currently significantly less than HELOC rates.
    5. The best way to determine how current refinance rates compare is through the use of a mortgage calculator. You can pit different loan terms against each other to see which makes the most financial sense.


    Home equity vs. refinance – which is best?

    Which is the best option depends upon the homeowner’s needs and the financial market. For very large amounts, refinance is generally best for long term borrowing. For short term or smaller loan amounts, home equity might be a better option. It’s always best to speak with a professional if you need help determining which option is best for you and your financial situation.


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