Mortgage Refinancing vs. Home Equity Loan

[Jul 1, 2009.]

 

Despite the troubled housing market, some homeowners have managed to hang on to a good amount of their home equity. Some of them may be considering cashing out some of it but aren't sure whether to use mortgage refinancing or take out a home equity loan. Let's assume they have good credit, a steady income, and can qualify for either type of loan. Here's how they compare.

Mortgage Refinancing

A cash-out refinance could allow a homeowner to get a better interest rate, but the monthly payments might be higher on the new mortgage loan depending upon the new principal amount. So why do a cash-out refinancing? If a person really needs to get their hands on some cash, refinancing could accomplish this while allowing them to continue making one monthly payment on a mortgage. But the drawback to this method is that a homeowner could end up with a much higher loan balance than he or she started with.

Taking out cash also could mean having to take on the additional cost of mortgage insurance. If refinancing results in the homeowner's equity in the home falling below 20%, the lender will require mortgage insurance. That would tack additional monthly fees on to the loan. Refinancing also requires a homeowner to pay closing costs, which could add up to thousands of dollars.

Home Equity Loan

A second mortgage, or home equity loan, also allows a homeowner to pull money out of a house, which is put up as collateral. The money can be accessed as either a lump sum, or through various draws with a home equity line of credit (HELOC). The advantage to a HELOC is that money can be withdrawn, paid off, and withdrawn again during the draw period, which is the number of years a person has to access money from the line of credit.

Home equity loans and HELOCs generally don't have closing costs, but interest rates tend to be higher than when refinancing. That's because if a homeowner defaults on paying the loans, the first mortgage has to be paid off before the second one. Home equity loans can generally  be found with fixed rates, but HELOCs usually have variable rates.

Is Cashing Out Equity Worth the Risk?

Cashing out home equity in this economy can be a risky proposition. Homeowners who think they are financially secure today could end up joining the ranks of the unemployed tomorrow. So it's important to run all the numbers carefully and compare home equity and mortgage loan packages from reputable lenders.

 

About Author:

Francine L. Huff is a freelance journalist and the author of The 25-Day Money Makeover for Women. She has appeared on a variety of TV and radio shows.