Refinancing or home equity loan – this is the general question home owners find themselves asking. It might do them good to understand what refinancing and home equity loan mean and the advantages and disadvantages of both these types of loans. It might be possible that a friend in similar circumstances as yours might have availed a home equity loan and might be finding it to be a good decision. This however wouldn’t mean that it would be best for you too. One must understand when to opt for refinancing and when home equity might work out for the best. Refinance means once again financing the current loan. In other words, it amounts to availing a new loan to pay off the current one. Home equity loan would mean tapping the equity built on the current mortgage, so that it may be utilized to pay off the current loan and other debts.

Refinancing may be of two types – simple mortgage refinancing and cash-out mortgage refinancing. In a simple refinance, a new refinance loan equal to the principal amount outstanding would be availed which would be paid to the lender of the current mortgage. In a cash out refinance, an amount more than the principal outstanding would be availed so that there would be money left over after paying off the mortgage that may be used for home improvements ,to pay for the children’s college fees or to pay off other debts. For example, Mr. Jones and Mr. Cutter; both availed a mortgage loan of $300,000. Both have paid off $100,000 on their mortgages and Mr. Jones got a refinance mortgage loan for $200,000 to pay off the outstanding principal of the mortgage whereas Mr. Cutter availed $250,000 of which he used $200,000 to pay off the outstanding principal and the remaining $50,000 he used for other purposes. Mr. Jones availed a simple mortgage refinance while Mr. Cutter availed cash out mortgage refinance.

Home equity loan refinancing, on the other hand would mean that you would be using the equity that you might have built into your home. Home equity means the difference amount between the current value of the home and the outstanding of your mortgage. For example, if your home’s current value is $400,000 and the outstanding mortgage would be $300,000, then your home equity would be $100,000. Home equity would be treated valuable but it wouldn’t mean that it may be converted into cash. It may be used to avail another loan where your home would be collateral. A home equity loan may be availed to consolidate debts, to pay off credit cards and to pay off any other debts. Usually this type of loan would have a higher interest rate. Availing a home equity loan might not mean that your original loan would reduce or that your monthly payments would reduce. It may so happen that in case you are not sensible in using this amount, you might end up with more loan than you originally had. A loan called the Home equity line of credit (HELOC) may also be availed. HELOC operates like a credit card as it would enable revolving credit with the amount of home equity being the credit limit.

Mortgage refinancing might seem to be the best option when you have a current mortgage that would be coming up for adjustment, the current mortgage interest rate that you might be paying might be higher and there might be a chance of getting a refinance at a lower interest rate or if you require cash out to make home improvements and pay off debts at a lower rate of interest rate. It must however be noted that as for the first mortgage your credit scores would play a major role in deciding the refi interest rate. The lender would require you to have good credit-rating, stable income and your debt-to-income ratio shouldn’t exceed 35% to give you the best rate of refinance interest. It would be prudent to check your credit report and get any errors corrected so as to improve the credit score. It might be helpful to shop around for the best refinance mortgage interest rates and terms before deciding on a particular lender. It would also prove to be beneficial to research the possible lenders before choosing one.

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Category: Finances
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