Puzzled by Home Equity Loans? You are in good company. With the many options available to you, it is easy to feel overwhelmed. Different types of home equity loans have a variety of features and benefits for homeowners. If you are thinking about making home improvements that will add value to your home, trying to lower your monthly payments on an existing home equity loan or line of credit or want to consolidate your debt, read on for a guide to piecing the puzzle together.
Second mortgages, home equity loans and home equity lines of credit all use your home as collateral and the interest on these loans is tax deductible. However, they differ on many levels. Although second mortgages and home equity loans are usually lump sum loans for a fixed period of time, depending on the type of loan you choose, the interest rate can be either fixed or variable. On the other hand, home equity lines of credit allow you to borrow money from the equity in your home in the same way a credit card allows you borrow money against your credit limit. In other words, you can continue draw off your equity up to the limit set by your loan.
Another piece of the puzzle is cash-out refinancing. Cash-out refinancing is different from home equity loans because it is a replacement of your existing mortgage, not an additional loan. With cash-out refinancing you can borrow more than the amount you owe on your home and use the additional cash you receive at your discretion. According to a recent article on Bankrate, homeowners must answer the following questions before beginning a cash-out refinance:
· Are you refinancing at a lower interest rate?
· Will your monthly payments decrease enough to offset closing costs and other fees associated with refinancing?
· How do you plan to spend the money?
If you are refinancing at a lower rate, are able to recoup your closing costs in a fairly short amount of time and are planning on spending the cash on something that will add long-term value to your home or life, then cash-out refinancing might be the piece of the puzzle that fits for you.
Many of the same considerations apply for refinancing an existing home equity loan. Most homeowners look at this option if they are trying to obtain a better interest rate, switch the loan from an adjustable to a fixed interest rate or avoid a balloon (large) payment at the end of the loan repayment period. How long you plan on staying in your home should be another factor in your decision to refinance your existing home equity loan. “If you plan to be there a long time, then it makes sense,” says Steve O’Connor, senior director of residential finance for the Mortgage Bankers Association of America, in a recent article from American Home Equity. If you plan on selling your home soon after refinancing your loan, you are less likely to recover the closing costs.
For those of you to whom debt consolidation is the main goal, your best option is most likely to apply for a home equity loan versus a line of credit or refinancing. Because home equity loans must be repaid within a specific time-frame, you won’t have to pay interest on your credit card debt for the entire length of your mortgage.
When looking over your options, be sure to consider your lifestyle and your comfort level with the type of loan you choose. If you’re a big spender, you might end up getting yourself in even more debt if you use the $20,000 from a cash-out refinance as a down payment on an exotic sports car. Or if you tend to be overly cautious, you may find yourself wishing you had taken out a larger home equity loan when your home improvement project goes over budget. That’s why the most important piece of the puzzle is you – the homeowner.