Using the Equity in your home - HELOC vs Cash Out Refinance
Witnessing the growing gap between the value of the home and the
remaining mortgage balance is something that all new homeowners look
forward to. That gap is known as "equity," and it is perhaps the chief
reason for owning a home. Equity combined with reasonably good credit is
the key to an essentially free source of cash. The idea of the home as
an asset gained traction in the 1970s and 1980s. It reached its full,
catastrophic flowering in the housing bubble from 2003 to 2007 and the
subsequent crash of 2008. Aside from these lamentable events, home
equity has been of great use to homeowners in recent decades.
Uses and methods of Equity Release Making home improvements, buying consumer goods, investing in a business
and helping a child pay for college are all common reasons to take
advantage of home equity. Two popular methods for accessing this
resource are a home equity line of credit (HELOC) and cash out
refinancing. HELOCs are akin to credit cards that use the equity in the
home as the credit limit. Cash out refinancing involves replacing the
current mortgage with a new one and pocketing the difference between the
balances. These two methods have much to recommend them but
disadvantages accompany each of them, as well. Interest Rates
Despite the strong negative pressure on interest rates, getting a HELOC
versus applying for a cash out refinance means differences in the rate
between them. A cash out refinance plan usually comes with a slightly
higher interest rate because the lender is advancing more money if
nothing else. Another complicating factor is the loan-to-value (LTV)
ratio. If the LTV is over 80 percent with a cash out refinance, the
lender will probably raise the interest rate higher as a defensive move.
A downside of a HELOC is that the interest rate is adjustable. Repayment OptionsA HELOC is much more flexible than cash out refinancing. The HELOC
allows the homeowner to take out only as much as the home equity amount
allows. There is no need to obtain a mortgage for the full value of the
house. This makes repaying any charges incurred on the line of credit
easier. Additionally, the interest rate can be converted into a fixed
rate if the homeowner wishes, but the fixed rate will be higher. A cash
out refinance has the disadvantage of having to pay the entire loan
balance as well as resetting the amortization schedule. On the upside,
the interest rate is already fixed and may be lower than what the
homeowner is paying now. HELOC-Appropriate Situations |
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HELOCs come in handy for variable expenses unrelated to daily living. A
child's tuition costs, consolidating higher interest debts or funding home improvement projects are good examples. The homeowner can charge any
amount he wishes to the HELOC as long as it does not exceed the value of
the equity. Borrowing money from the HELOC on an as-need basis results
in lower finance charges.
HELOCs are divided into draw periods and pay periods. The draw period
lasts between five and 10 years, during which the borrower is only
required to pay the interest. The repayment period lasts longer, between
10 and 20 years. HELOCs are designed for borrowers that need to pay for
a certain expense in the present, but can defer repaying to some future
date. This makes them well-suited for handling the types of expenses
mentioned above, such as making home improvements, investing in a
business or paying tuition expenses.
