There are a variety of ways to borrow against your home’s equity.
Refinance Loan
At some point, you may think about changing your mortgage payments or terms by refinancing. Refinancing is when you get a new mortgage and use some or all of the proceeds to pay off the old mortgage. When you refinance, you complete many of the same steps you did when you got the first mortgage to buy your home. Since a refinance represents a replacement to your mortgage, borrowers use it in a number of ways:
Refinancing to save money on your interest rate. If interest rates are lower now than when you got your current mortgage, you could reduce your monthly payments and the total amount of interest that you pay over the life of the loan by refinancing at a lower rate. When considering this option, determine your break-even point. This is how long it would take you to recapture all of the costs of refinancing (closing costs, fees, points, and any prepayment penalties) through savings from the new mortgage payment. Do you plan to stay in your home for longer than it could take to recover your costs? If so, the savings you accumulate could be worth refinancing.
Refinancing to lower your monthly payment. If you would like to reduce your payment, you could either extend the term of your loan or switch to another loan product with a lower interest rate. If you choose to lengthen your loan term, it will take you longer to own your home outright and cost you more in overall interest charges and total costs associated with your loan.
Refinancing to convert one type of mortgage to another. What if your original mortgage is no longer the right fit for you? You could refinance to obtain a different loan type. If you have an adjustable-rate mortgage (ARM) and wish to switch from an interest rate and monthly payment that will likely increase, you could change to a fixed-rate mortgage. If you’re OK with a fluctuating interest rate, you could look for an ARM with a lower rate or better features. If you would like to improve the terms on a second mortgage, you could either refinance this loan with a better product or refinance both your first and second mortgages into a new first mortgage loan. If you have a balloon/reset mortgage, you must pay the mortgage in full at the end of the five- or seven-year term or consider refinancing.
Refinancing to build equity faster. If your financial situation has improved since you bought your home, you may want to get a mortgage with a shorter term. Your monthly payments will most likely be higher, but this will help you own your home sooner and pay less in total interest charges.
Refinancing to take cash out. This loan replaces your old mortgage with a larger one, and you keep the difference between the loan amounts to use for your intended goals. While the cash-out refinance is attractive, the interest rate could be higher than the rate would be if you were simply changing the terms of your loan. And remember that your total loan amount will be higher because you do need to pay back that “cash out.”
Home Equity Loan
This is a mortgage secured against your home. It is in addition to your existing mortgage. You borrow a set amount of money as a second mortgage or “junior lien.” Second mortgage loans usually have fixed interest rates that are higher than first mortgages. Home equity loans are often structured as 10- or 15-year loans—that’s a long time to pay it back! If you use the funds for a new car or vacation, the car will likely need to be replaced and most of your vacation memories will be long gone before you finish paying off your loan, so think carefully before you do that.
Home Equity Line of Credit
This is a specialized form of a second lien that is also secured against your home. A line of credit, in many ways, is similar to a credit card. It is a revolving line of credit, where the balance can go up or down. You can borrow money (up to the amount that has been approved) and pay it back as many times as you need during the term of the loan. Interest rates for lines of credit are usually variable, but you only pay interest on the amount you borrow.
Home Equity Conversion Mortgage (HECM)
A type of reverse mortgage that is an option for homeowners who can actually turn their equity into income. With the Department of Housing and Urban Development’s (HUD’s) government insured HECM, instead of making their monthly mortgage payments, seniors with HECMs can choose to receive monthly payments or access a line of credit. The borrowing homeowner must be at least 62 years old, live in the home, and be willing to receive counseling before obtaining the loan to ensure a good fit and either own the home outright or have a really low balance. For more information and conditions, please visit http://www.hud.gov/.
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