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Refinance? Home Equity Loan? How To Decide Wisely
By EchoBay Loans Staff Writer

If you're a homeowner who is looking to make a large purchase or facing a substantial financial expense, you've probably considered using the equity in your home to help you with your financial burdens. Whether you're looking to make home repairs, purchasing a new car, or trying to reduce your credit card debt, most homeowners are aware that refinancing their homes or taking out a home equity loan can be an easy way to find the excess cash they need. The question that comes into play is, which of these two loan types is the one that's best for you?

The first step in deciding which option is right for you is to understand the distinct differences between these two loan types. When refinancing your home to gain access to extra funds, you're going to need to do what's called a cash-out refinance. This is when you refinance more than just what is owed on the original mortgage of your home.
For example, if your home is worth $250,000, you owe $125,000 on your original mortgage and you need $50,000 for home repairs and remodeling, you can refinance your home for $175,000 and get access to the cash you need to remodel your house.

When you take out a home equity loan, sometimes called a second mortgage, rather than refinancing your entire mortgage, you are taking out an additional loan against the equity that you have built in your property. The equity you have in your property is determined by the amount your property is worth versus the amount you owe on the property. The difference between the two is your total equity value.

Home equity loans can be a set lump sum amount that is paid over a specified period of time (just like a regular mortgage), but more frequently, they are revolving lines of credit. This means that you can borrow against the loan when you need access to funds and pay the loan back in monthly installments. As you pay the loan back, your credit line increases, similar to the way a credit card works but with much lower interest rates.

Deciding which loan type is best for you will depend on a number of circumstances and factors, and almost all of these factors point to costs. Interest rates play a large role in this decision. If today's interest rates are substantially lower than the rates that were available when you took out your existing mortgage, a cash-out refinance will serve a dual purpose. You will be able to lower your current interest rate while gaining access to the extra cash you need. In certain circumstances, your new monthly mortgage payment might be comparable to, or even less than your previous mortgage payment even though you are borrowing more money.

However, if today's interest rates are higher than that of your existing mortgage, you will want to go with a home equity loan rather than refinance your existing mortgage at a higher rate. In this scenario, you won't have to pay a higher interest rate for your current mortgage and you also will avoid having to pay the closing costs associated with refinancing. Even though closing costs on a refinance may be tax deductible, when you borrow from a home equity loan, you can avoid this expense altogether.

You also need to consider what you're borrowing the money for. If you are refinancing your home with a 30-year mortgage, you have to ask yourself if what you're spending the extra cash on is something that you want to be paying for up to thirty years from now. For instance, if you're purchasing a new car, do you really want to be paying for that car for thirty years, when chances are that car will no longer be around when the loan is paid off? However, if you need the cash to make home improvements, paying for those improvements over the course of your mortgage makes much more sense.

Another thing to consider is how much of your home's equity you are going to need to tap into. If you need to borrow more than 80 percent of your home's value, you're going to want to go with a home equity loan. A cash-out refinance at over 80 percent of your home's total value is going to require you to pay private mortgage insurance, and that is an additional expense that you don't need.

A final determining factor should be the difference between what the loans are going to cost you now and how much they're going to cost you over the length of the loan. Look at your amortization schedules. Figure out how much you would be required to pay monthly if you were to refinance, and how much the total monthly payment would be if you added a home equity loan payment to your existing monthly mortgage payment.

Then figure out how much both will cost you in the long run by figuring out how much the total payments of a refinanced mortgage would be, and how much the total payments of your current mortgage and the total payments of your new home equity loan totals up to. The difference could equal thousands of dollars. By taking all of these factors into consideration, it should be much clearer which loan type is right for you.

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