All About Home Equity Loan or HELOC and Cash-Out Refinance

Jan 05, 2023 By Susan Kelly

There has always been a better time to cash in on your home's equity, but doing so can get pricey if you do it right. According to a report from data analytics firm CoreLogic published in June 2022, homeowners earned an average of $63,600 in equity between the first quarters of 2021 and 2022, thanks to a hot housing market and surging property values. During this same time, interest rates have skyrocketed as a result of multiple increases to the federal funds rate by the Federal Reserve.

Cash-out refinancing had declined in popularity since the financial crisis when mortgage rates were significantly lower. It seeks to capitalise on its rising home equity without risking the loss of its historically low mortgage rate.

Equity loans are a low-cost option to finance anything from home upgrades to debt consolidation by using the value of your home as collateral instead of your mortgage. However, you should not lightly risk losing your home by using it as collateral for a loan.

When rates were at historic lows, homeowners who made their purchase or refinance in 2020 or 2021 may be reluctant to refinance at a higher rate. In several situations, a home equity line of credit (HELOC) or loan may be less expensive than refinancing your principal mortgage.

Explaining Home Equity Lines

During the draw period, you can make withdrawals from your line of credit up to the maximum, and during the payback term, you must repay the withdrawals in full (plus interest).

Since a home equity line of credit (HELOC) does not replace or alter your primary mortgage like a cash-out refinance, the two are sometimes grouped under the umbrella term "second mortgage." Instead, you'll have a new loan on top of your current first mortgage, with its own set of terms and conditions and monthly payments.

Due to the nature of HELOCs as variable-rate products, your interest rate will be calculated as a percentage of the lender's margin added to the prime rate. Your HELOC interest rate and payment will adjust along with any changes to the prime rate caused by market conditions. Getting a HELOC with a fixed rate or rate lock is possible, but not all lenders provide this choice.

A Cash-Out Refinance

With a cash-out mortgage refinance, you take out a new mortgage for a larger amount than your present one and use the difference to pay off your existing mortgage. You'll continue making regular payments on your new mortgage as per the loan's terms.

The percentage of ownership you have in your home is expressed as a percentage of its value. With a cash-out refinance, you can borrow up to $100,000 more than what you now owe on your mortgage. After deducting closing fees, you will get $100,000 in a single cash payment. But your home equity will drop from $200,000 (60%) to $50,000 (20%) if you do this.

Remember that your loan term will start over after a cash-out refinance. For example, if you refinance 10 years into a 30-year mortgage, you'll start the new loan's amortisation period from the year

Home Equity Line of Credit

Both home equity line of credit loans and cash-out refinance loans have advantages and disadvantages. A cash-out refinance a type of mortgage refinancing in which the existing mortgage is paid off and replaced with a new one with different interest rates and terms. If the interest rate at which you can refinance your mortgage is higher than the interest rate at which you took out your original mortgage, then the full loan amount, not simply the sum you're borrowing, will be subject to the higher rate.

The other hand is a second mortgage or additional loan in addition to your original mortgage. It's a great method to get cash out of your house without changing your principal mortgage.

Most cash-out refinances are fixed-rate mortgages with 30-year or longer payback terms and equal monthly payments. Remember that the interest rate on a home equity line of credit (HELOC) will rise and fall along with the prime rate. Credit card interest rates are also variable and will likely remain lower than HELOC rates, although HELOC rates are predicted to continue increasing in tandem with market rates.

Monthly HELOC payments are necessary, but the minimum payment during the draw term is typically merely interest. However, you can pay more than the minimum if you choose, which is a good idea. A larger down payment might reduce your total interest and principal payments over the life of the loan.

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