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Mortgage debt accounts for the majority of consumer debt. This 2020 NAR Trends chart highlights that the average mortgage loan debt has steadily increased between 2015 and 2019. The total four year increase in this segment is a significant 10%. This suggests a trend of increasing mortgage debt that correlates with the rising house prices.
People often say that there’s no romance without finance. Moreover, you can’t remodel your kitchen, buy a new car, or pay for college without having finances.
Considering the heavy monthly mortgage payment, some of our biggest investments often require outside help that’s either in the form of a loan or line of credit.
What is The Best Option For Borrowers Seeking Extra Cash?
If you are a homeowner that needs additional funds to subsidize a big purchase or debt, getting a personal loan with a high-interest rate is not always the best option. Here are better options that people use today: a home equity loan, home equity line of credit (HELOC), or a cash-out refinance.
Home equity lines of credit are loans that allow the homeowner to borrow against the equity in their property. This can be an effective way to restructure finance, pay for home improvements or pay for a significant purchase.
As the following chart using FED Survey of Consumer Finances 2019 data, the average by family lines of credit fluctuates over time. In 2001, the average was at a low of $37,000 per family. This peaked in 2010 at $64,000.
What is a Home Equity Loan (HEL)?
This type of loan allows you to borrow a fixed amount by using your home as collateral. The lender will give you the money in a lump sum. Moreover, how much money you receive hinges on the loan to value ratio, payment term, verifiable income, and credit history.
In normal cases, a HEL has a fixed interest rate, term, and monthly payment. The amount of interest that you pay on your home equity loan is 100% tax-deductible. It’s important for you to speak with your tax advisor regarding this as well.
Recap – Home Equity Loan:
- Your first mortgage is left alone
- You pay less in acquisition costs than for a cash-out refinance
- The amount of interest on the loan is tax-deductible
- Normally, the interest rate is higher than a cash-out refinance, the fees are higher than a HELOC
Who is this good for?
This is a good option for those who need money for a single case and desire the comfort of fixed-rate loans. In addition to, it’s a good option if you don’t want to refinance but keep your existing mortgage along with receiving a lump sum of money.
What is a Home Equity Line of Credit (HELOC)?
A HELOC is a type of revolving credit that enables people to borrow with their homes being collateral. Lenders approve people by taking a percentage of their home appraisal value and subtracting the balance they owe on the existing mortgage. Lenders will also determine this factor by your income, other debts, and credit history.
Getting a HELOC allows you to spend the money (up to the credit limit) on anything without restrictions via a credit card or special checks. On the other hand, there are plans that place restrictions and guidelines in regards to you borrowing a minimum amount each time, withdrawing an initial advance when the line of credit is established, or keeping a minimum amount outstanding.
According to Josh Hastings, CEO of Money Life Wax – The pros of using a home equity line of credit (HELOC) is that unless you plan on selling your home in the near future, equity is a dormant asset. So leveraging your equity to payoff your student loans or even your house quicker is just another reason why leveraging a HELOC is a great idea!
Home Equity Line of Credit plans allow you to withdraw the money you need over a set period of time. This is known as the “draw period”. Moreover, you have the ability to renew your credit line and continue to withdraw money at the end of the period. Don’t be ignorant of the fact that not all lenders allow renewals.
On top of that, there are lenders that demand borrowers to pay back the amount they withdrew at the end of the draw period. Some lenders may grant you the ability to make payments over another time period which is known as the “repayment method”.
Recap – HELOC:
- With a HELOC, by a shoer negotiation, you'll be able to reduce the interest rate to be lower in comparison to a home equity loan (HEL).
- Because of little to no restrictions, they are quicker and easier to secure
- You withdraw the money on an at-need basis and pay zero interest until you do
- Your payments can be high due to the fact that the interest rate is adjustable which means it can rise at any time
Who is this good for?
For those who need extra funds accessible to them over a period of time. For instance, if you’re remodeling, you can withdraw from the credit line periodically to pay the contractors. They also provide a way for people to have access to cash without having to pay interest unless you withdraw from it.
A cash-out refinance is a refinance of your current, existing mortgage loan. This type of refinance allows one to get a new loan to pay off the current one. Moreover, it also takes out the equity (the difference between the worth of your property and how much you owe on the mortgage) via a single, lump-sum cash payment.
A cash-out refinance is also a fixed-rate loan which can last for 30, 20, or 15 years by offering a very low-interest rate. One thing to note is that the current national average rate (October 2021) for a 30-year fixed mortgage is 3.3% even though the rate for a cash-out refinance is higher (especially if you desire to roll the closing costs into the loan amount). This type of refinance also places a new first position lien on your property over the amount that you currently owe.
It’s also good to know that the phrase “first position” points towards the order of the recording by your county clerk, which dictates which mortgage you have to pay first if you default on the loan.)
Recap – Cash-out Refinance
- It enables individuals to lower their current interest rate so they can take advantage of a lower total rate than they would by having a home equity loan or HELOC
- There are only one loan and one payment
- The interest on this type of loan is tax deductible
- The first mortgage is reset, which could add more years to the term until you pay it off in full
- You have to borrow all of the money at a single time and begin making payments immediately every month
- The process of closing can be very long with closing costs being at 7% of the total loan amount (although you can choose a no-closing-cost option that combines your closing costs into a higher interest rate.)
Who is This Good For?
This is a good option for you if you have a lot of equity built up and you want to refinance your entire mortgage. People have many reasons to refinance such as taking advantage of lower rates or changing from an ARM to a fixed-rate loan.
Another good thing to note is that if you plan to refinance and need additional cash, the cash-out refinance solve both problems.
Home Equity Loans Vs HELOC
While home loans and lines of credit are similar in some ways, there are significant differences that make one or the other preferable in a given situation:
|Repayment terms||Fixed payments that start as soon as loan is disbursed||Interest-only payments during draw period; repay principal and interest afterward|
|Getting Funds||Lump sum||When needed|
|Cost & Fees||Depends on the lender||Depends on the lender|
|Risk||Depends on loan amount and your ability to repay it||Depends on revolving credit amount and your ability to repay it|
A home equity loan is a second mortgage that allows you to borrow against your home's equity in one lump sum. Some home equity loans allow you to borrow up to 100% of your available equity, while others cap the loan at 85%, 90%, or 95% of your available equity. Home equity loans typically have fixed interest rates.
A HELOC differs from a home equity loan in that you can borrow only what you need now while potentially borrowing more in the future.
The credit line is similar to the amount of credit available on a credit card. You only pay interest on the money you use.
With a home equity loan or a HELOC, your repayment can be amortized, which means it can be spread out over time, with interest and principal included in your installments.
Get quotes for both HELOCs and home equity loans as you research to see which one offers a lower interest rate, fewer fees, and better terms. Also, consider your financial situation and which option is best for you.
Cash-Out Refinances Vs Home Equity Loans
- You get your money right away. Whether you choose a cash-out refinance or a home equity loan, you will receive a lump sum cash payment as soon as the transaction is completed. You can spend the money on whatever you want.
- You borrow against your home's equity. Because both of these loans use your home as collateral, you can get lower interest rates on cash-out refinances and home equity loans than you can on other types of loans.
- You can't take out all of your home's equity. The majority of lenders and loan types require borrowers to leave some equity in their home.
- Cash-out refinances are considered first loans, whereas home equity loans are considered second loans.
- Cash-out refinances pay off your current mortgage and replace it with a new one. Home equity loans, on the other hand, are a separate loan from your mortgage that adds a second payment.
- Interest rates on cash-out refinances are lower. Cash-out refinances typically have lower interest rates because they are first loans (meaning they are paid first in the event of a foreclosure, bankruptcy, or judgment).
Cash-Out Refinances Vs HELOC
You have options if you want to borrow against the available equity in your home. One option is to refinance and take cash out. Another option is to obtain a home equity line of credit (HELOC). The following are some key distinctions between a cash-out refinance and a home equity line of credit:
- Interest rates: Cash-out refinance is possible with either a fixed-rate or an adjustable-rate mortgage. The interest rate on a home equity line of credit (HELOC) is variable and changes in tandem with an index.
- Loan Terms: A cash-out refinance pays off your existing first mortgage. This results in a new mortgage loan with terms that may differ from your original loan (for example, you may have a different type of loan and/or a different interest rate, as well as a longer or shorter time period to pay off your loan). Typically, a home equity line of credit (HELOC) is taken out in addition to your existing first mortgage. It is considered a second mortgage and will have a separate term and repayment schedule from your first mortgage.
- Getting Your Funds: When you close your refinance loan, you will receive a lump sum from cash-out refinance. A home equity line of credit (HELOC) allows you to withdraw funds from your available credit line as needed during the draw period, which is typically 10 years.
- Closing costs: Closing costs for a cash-out refinance are similar to those for your original mortgage. Closing costs for a home equity line of credit (HELOC) are typically nil (or very low).
Cash-Out Refi, Home Equity Loan or HELOC – Which is Better?
You have to consider important things before choosing one of these financing options.
Making the right choice is contingent on your current circumstances, the amount you need to borrow, the condition of your existing first mortgage, your income, and cash flow, and your tolerance for risk.
Since HELOC’s are neither subject to Dodd-Frank rules nor truth-in-lending regulations, people can obtain one easily. The next easiest are equity loans. The only deal is this… there are limitations on the sources and they are expensive. Even though a cash-out refinance are difficult to obtain, it’s a good option if you don’t have a big mortgage because they cost less in most cases.
Here’s another tip: before applying for a HELOC or home equity loan, consider the following: the amount of money you actually need, and how you plan on using the money. Also, it’s important to take into account the interest rates, fees, monthly payments, and tax advantages before applying. You can always use our HELOC calculator to get a good estimation of those factors.
The benefit of utilizing the equity of your home before you sell is a powerful tool (benefit) at your disposal. The downside is that you’re using your home as collateral. Here’s the main thing you need to avoid while choosing a HELOC or a loan: Stay away from funding short-term needs that could turn out being a long-term loan.
Should I Take a Personal Loan Instead?
Your credit scores and credit reports are important in lending decisions. It is a good idea to get a complimentary copy of your reports before applying for personal loans. This will allow you to understand the criteria that lenders will use when considering your application. You can always check your credit score as many times as you like.
After you have reviewed your credit reports, you will be able to determine what type of loan is available. Lenders are more selective than others in approving applicants. If they provide them, you can find out the minimum credit score requirements of lenders to see where you stand.
People with high-quality credit ratings usually get the lowest interest rates. If you don't have good credit, it might be difficult to find a personal loans at a low rate. Before applying for a personal loan, if you have a lower credit score, it might be worth spending time improving your credit scores. This will increase your chances of receiving a low interest rate, and can help you save money over your loan's life.
Shop Around & Compare Your Options
You are typically paying more than the principal amount of a loan when you repay it. A portion of your monthly payment may be used to pay interest and fees depending on the terms of the loan.
You could save thousands of dollars by paying attention to the costs of new borrowing. These are the things you should pay attention to when looking for a loan.
- Rate of interest: When shopping for a loan, you should consider the impact of interest rates. Although your credit score will determine the rate you get, rates can vary depending on which lender you choose and what type of loan they are.
- APR Your: The APR (or interest rate) includes fees associated with borrowing money. This number can be used to determine the exact cost of your loan. While APRs can be used in conjunction with interest rates in certain cases, it is important to understand the details when you are considering different loans.
- Monthly payment: You'll be responsible for a monthly payment each month throughout the term. This monthly payment will pay money towards principal reduction and a portion of total interest over the term.
Fees You can find out the fees and extra costs associated to your loan by reviewing your borrowing agreements. These fees include late fees, prepayment penalties and origination fees. These fees can raise the cost of borrowing so be sure to understand the details.
Term. It is important to know the term, or the time period over which you agree repay your debt. This, along with your interest rate can help you determine how much you will be paying each month. Longer terms have lower monthly payments. Shorter terms are more expensive. Keep in mind that interest is charged on borrowed funds over the term of the loan. The longer you wait to repay the debt the higher the interest rate.
Limiting the number of loan applications you send can help you keep your credit score strong if you are in the market for a loan. A hard inquiry is a request for your credit report by a lender to approve a loan application. Hard inquiries can remain in your credit file for as long as two years. They can also have a negative effect on your score if they are repeated too often.
There are a number of reasons for taking out a loan, but this can also influence the average loan amount. In this chart with LendingTree customer data, you can see that credit card refinancing has the highest average loan amount followed by debt consolidation.
You will need to complete the application process before you can ask any lender for credit. Before you apply for a personal loan, you should review your credit history and credit score. This will help you understand what lenders may see in your credit reports and scores. You can always check your credit reports as many times as you like.
After you have reviewed your credit report and taken the necessary steps to correct any errors, you can apply online for a personal loan from any financial institution, such as a bank or credit union. Each lender that you apply to will review your credit score and report.
Home equity loans are a good option if you need a large sum of money quickly, yet you don’t want to overspend. You can access the equity accumulated in your property with a fixed interest rate. This will allow you to know exactly how much you will need to repay each month and budget accordingly.
Since a cash out refinance replaces an existing mortgage with a larger, new mortgage, you can access a large sum of money at a low interest rate. This is potentially a cheaper way to borrow and you can use the cash as you like.
This can be a good option if you don’t want to worry about dealing with two monthly repayments, as you would with a mortgage and home equity loan.
Taking on new debt usually causes a slight drop in your credit score. However, if you replace an existing loan with one of roughly the same size, the impact on your credit score should be minimal.
In fact, if you refinance to increase your disposable income, you are more likely to be able to meet your monthly repayment requirements on all of your financial obligations, which will benefit your credit report in the long run.
Depending on the terms of the refinance, you may be able to sell your home after a cash out refinance. Some lenders include an owner occupancy clause that requires you to live in the home for a certain amount of time before renting or selling it. This could be an open-ended clause with no expiration date in some cases.
If your contract includes an owner occupancy clause, you may run into issues with the mortgage company during the closing process. Before you put your house on the market, double-check the loan documentation.
Due to the fact that a HELOC is a line of credit based on the equity in your home, lenders do require an appraisal. To calculate the available equity, the lender will need to confirm the value of your property as well as your current mortgage balance.
If your appraisal does not confirm the value of your home, you may have difficulty obtaining your HELOC. The lender requires enough equity so that if you default on your loan, it can recoup the outstanding debt even after your mortgage has been paid off.
Most HELOC plans allow you to pay off the account's remaining balance at any time. If you pay off the entire balance early, your lender will most likely give you two options: close the line of credit or keep it open for future borrowing.
However, it is critical to be aware of any potential consequences. Some HELOCs have early repayment penalties. As a result, it is critical that you read the fine print before making your final decision.
You can negotiate your HELOC rate, just like you can with a conventional mortgage, but you must do your homework. There are numerous companies competing for your business, so you may be able to find more advantageous quotes for a new HELOC deal. These quotes can then be used to negotiate the rate with your current HELOC provider.
However, you should be prepared to switch to a new provider. If your current lender is unable to match the rate on your best offer, you must consider the costs of switching providers before proceeding. For example, it's pointless to save $50 per month if you have to pay $5,000 in early repayment fees and charges.