January 7th, 2018 5:38 AM by Jackie A. Graves, President
If you need to tap into your home equity for
home improvement, a large expense, a new investment, or just some extra cash,
you have three main choices: a home equity line of credit (HELOC), a home
equity loan, or a cash-out refinance. Let’s take a closer look at each of these
mortgage products so you can determine which one best meets your objectives.
Home Equity Line of
What it is:
A HELOC is an adjustable rate home loan that you can access
a lot like a credit card. It has a credit limit that you can draw from and pay
down over a set draw period, typically 10 or 20 years. Your payment is based on
your balance each month.
Some HELOCs require you to pay only the
interest due on the outstanding balance, which means you’re not paying the
balance down, and some require a principal and interest payment, which means
your payment will be higher, but you’re paying the balance down.
A HELOC is often a second mortgage behind your
primary first mortgage, but it doesn’t have to be. If you had no first
mortgage, you could put a HELOC in place as your only loan.
Most HELOCs qualify you buy using a payment
that’s significantly higher than you’d actually be required to make. They do
this because HELOC rates are adjustable, and lenders want to account for rates
(and therefore payments) moving higher in the future.
Most HELOCs also have a “fixed-rate draw” or a
“fixed-rate advance” option which allows you to draw a portion of the HELOC
balance at a fixed rate. This will protect you from future rising rate risk,
but rates for fixed-rate draw are usually higher than the HELOC rates at the
time of the fixed-rate draw.
HELOC rates are determined by adding the Prime
Rate to a base rate called a margin. The Prime Rate can move as the Fed adjusts
rates each year. Your margin is based on your credit score and how much equity
you have in your home.
Home Equity Loan
A home equity loan is simpler than a HELOC in that it’s
just a lump sum loan. It’s a second mortgage that goes in second lien position
behind a first mortgage. This is different than a HELOC that could be your one
and only mortgage, because if you owned your home outright and needed cash in a
lump sum, you’d get a cash out refinance and it would just be a first mortgage.
Comparing home equity loan vs. HELOC rates, a
home equity loan rate will typically be higher because it’s a fixed-rate loan,
whereas a HELOC is adjustable.
Comparing a home equity loan vs. a cash out
refinance, a home equity loan rate will typically be higher because it’s a
second mortgage, whereas a cash out refinance is a first mortgage.
Home equity loans are typically fixed for 20
or 30 years, and they qualify you with their fully amortized payment.
Cash Out Refinance
A cash out refinance is a first mortgage that allows you to
take cash out of your home. If you own your home outright, the entire balance
of a cash out refinance (minus closing costs) would be net proceeds to you. If
you had a loan balance on your home from purchasing it using a loan, a cash out
refinance would be a new loan for greater than the existing balance, and the
difference between the existing balance and the new balance would be net
proceeds to you.
Comparing a cash out refinance vs. HELOC, cash
out refinance rates will be lower because it’s a first mortgage.
Comparing a cash out refinance vs. refinance,
traditional refinance rates will be lower because there is a rate premium for
taking cash out.
Cash out refinances can be fixed or adjustable
rates. Fixed rates qualify using the payment. Adjustable rates will often
qualify using a payment that’s higher than you’d actually be required to make
because they need to account for the fact that rates will move higher in the
If you’ve had a HELOC or a home equity loan as
a second mortgage in the past, you can combine that second mortgage with a new
cash out refinance first mortgage to consolidate all your debt into one single
loan. Ask your lender to present options to you, because it will
depend on how much equity you have.
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