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Your home is not just a place to live, and it is not just an investment. It is both, and more. Your home can also be a useful source of cash for emergencies, repairs or renovations. The process of freeing up the money you put into your mortgage is called mortgage refinancing, but there are several ways to do it.
A cash-out refinance pays off your old mortgage in exchange for a new mortgage, ideally at a lower interest rate. A home equity loan gives you money in exchange for the equity you’ve built up in your property, as a separate loan with separate payment dates.
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First, let’s cover the basics. Cash out refinancing and home equity loans are types of mortgage refinancing. There are several other types of mortgage refinancing, and you should consider whether refinancing is right for you before looking at the differences between cash-out refinancing and home equity loans.
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At the most general level, there are two common ways to refinance a mortgage, or refi. One is a rate and term refinance, in which you effectively swap your old mortgage for a new one. In this type of refinance, money does not change hands, except for the costs associated with closing and money from the new loan paying off the old loan.
The second type of refi is a set of different options, each releasing a portion of your home equity:
So why would you want to refinance your mortgage? Well, there are two main reasons: to lower the total cost of your mortgage or to free up some of the equity that would otherwise be tied up in your home.
Let’s say 10 years ago when you first bought your home, your 30-year fixed rate mortgage had interest rates of 5%. Now, in 2021, you can get a mortgage at an interest rate of 3%. These two points could cut hundreds of dollars a month off your paymentand even more off the total cost of financing your home over the life of the loan. Refinancing would benefit you in this case.
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Even if you are satisfied with your repayments and the length of your mortgage, home equity loans may be worth considering. Maybe you already have a low interest rate, but you’re looking for extra money to pay for a new roof, add a deck to your house, or pay for your child’s college education. This is a situation where a home equity loan could be attractive.
Before looking at the different types of refinancing, you need to decide if refinancing is right for you. Refinancing has several benefits. It gives you:
However, you should not think of your home as a good source of short-term capital. Most banks will not loan you more than 70% of the home’s current market value, and refinancing costs can be significant.
Mortgage lender Freddie Mac recommends budgeting about $5,000 for closing costs, including appraisal fees, credit reporting fees, title services, lender origination/administration fees, inspection fees, underwriting fees and attorney’s fees. Closing costs are likely to be between 2% and 3% of your loan amount for any type of refinance, and you may be subject to fees depending on where you live.
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Regardless of the type of refinancing, you should plan to live in your home for a year or more. It might be a good idea to do a rate and term refi if you can recoup your closing costs with a lower monthly interest rate within about 18 months.
If you don’t plan to stay in your home for a long time, refinancing may not be the best option; a home equity loan may be a better option because closing costs are lower than a refi.
A cash-out refinance is a mortgage refinancing option in which an old mortgage is replaced with a new one for more than the amount owed on the existing loan. already, helping borrowers use their mortgage to get money. You usually pay a higher interest rate or more points on a drawdown mortgage refinance, compared to a rate and term refinance, in which the mortgage amount remains the same.
A lender will determine how much money you can get with a cash-out refinance, based on banking standards, your property’s loan-to-value ratio, and your credit profile. A lender will also evaluate the terms of the previous loan, the balance needed to repay the previous loan, and your credit profile. The lender will then make an offer based on the underwriting analysis. The borrower gets a new loan that pays off his previous one and locks him into a new monthly installment plan for the future.
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With a typical refinance, the borrower would never see cash on hand, just a reduction in their monthly payments. A cash-out refinance can achieve a loan-to-value ratio of around 125%. This means that the refinance will pay off the amount and then the borrower can qualify for up to 125% of the value of their home. The amount beyond the mortgage repayment is given in cash, just like a personal loan.
On the other hand, cash refinances have some disadvantages. Compared to rate and term refinancing, drawdown loans typically come with higher interest rates and other costs, such as points. Repossession loans are more complex than a rate and term loan and generally have higher underwriting rates. A high credit score and relatively low loan-to-value ratio can ease some concerns and help you get a better deal.
Home equity loans are one option when it comes to refinancing. These loans usually have lower interest rates than unsecured personal loans because they’re secured by your property, and that’s the catch: the lender can come after your home if you change.
Home equity loans also come in two forms: the traditional home equity loan, where you borrow a lump sum of money, and a home equity line of credit (HELOC).
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A traditional home equity loan is often referred to as a second mortgage. You have your primary mortgage and are now taking out a second loan against the equity you have built up in your property. The second loan is subordinated to the first – in which case, the second lender steps up behind the first to collect any money owed from the foreclosure.
Home equity loan interest rates are usually higher for this reason. The borrower has more risk. HELOCs are also sometimes called second mortgages.
A HELOC is like a credit card tied to the equity in your home. For a fixed period of time after you get it, called the drawdown period, you can usually borrow as much or as much of this line of credit as you want, although some loans require an initial drawdown of fixed minimum.
You may be required to pay a transaction fee each time you make a withdrawal or an inactivity fee if you do not use your line of credit at any time for a predetermined period of time. During the drawdown period, you only pay interest on what you borrowed. When the withdrawal period ends, your line of credit also ends. You will start repaying principal and interest when the repayment period begins.
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All home equity loans typically have a fixed interest rate, although some are adjustable, while HELOCs typically have adjustable interest rates. The APR for a home equity line of credit is calculated based on the loan’s interest rate, while the APR for a traditional home equity loan usually includes loan origination costs.
Home equity loans have several advantages that can make them attractive options for homeowners looking to lower their monthly payments and free up a chunk of cash at the same time. Refinancing with a home equity loan can offer:
Discrimination in mortgage lending is illegal. If you believe you have been discriminated against based on your race, religion, sex, marital status, use of public assistance, national origin, disability or age, there are steps you can take. One of those steps is to file a report with the Consumer Financial Protection Bureau and/or the United States Department of Housing and Urban Development (HUD).
In principle, cash refinancing gives you the fastest access to the money you have already invested in your property. With a cash-out refinance, you pay off your current mortgage and enter
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In a new one. This simplifies things and can save a lot of money very quickly, money that can even help improve the value of your property.
On the other hand, a cash-out refinance tends to be more expensive in terms of fees and percentage points than a home equity loan. You must also have an excellent credit rating to be approved for a cash-out refinance, as the underwriting rates for this type of refinance are generally higher than for other types.
A home equity loan is easier to get for borrowers with low credit scores and can free up as much equity as a cash-out refinance. The cost of home equity loans tends to be lower than a cash-out refinance, and this type of refinance can be much more complicated.
Home equity loans also have their drawbacks. With this type of refinancing, you
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