Introduction

When a homeowner thinks about the value of his/her house, he/she may start thinking about how it is possible to get some money for other uses such as for shopping, paying off some debts or in case of emerging needs. Two ways of borrowing money against home equity are refinancing and home equity loans, but they are different, and each has its benefits and drawbacks. At Beach Community Mortgage, we will explain these options, their advantages and disadvantages to ensure that you make the right decision. Now, let’s look at how refinancing and home equity loans operate and which option may be right for you.

Understanding the Basics: Refinancing Vs Home Equity Loan

Refinancing

Refinancing usually means that you pay off your existing mortgage with a new one, usually because of better interest rates or other loan conditions. If you refinance your mortgage, you can also request a cash out, which means receiving a large sum of money by raising your loan amount.

Key Benefits of Refinancing:

  • Lower monthly mortgage payments if interest rates have dropped.
  • Potential to shorten your loan term, such as moving from a 30-year to a 15-year mortgage.
  • Option to cash out a portion of your home’s equity, often at competitive interest rates.

Home Equity Loan

A home equity loan is also known as a second mortgage – it is a separate loan and you are borrowing money against the value of your home. However, it is not a new mortgage that erases your current mortgage but an extra amount that is paid every month. Home equity loans generally have a fixed interest rate and are a single payment made at the time of borrowing, which is paid off in equal installments.

Key Benefits of a Home Equity Loan:

  • Fixed interest rates, offering predictable monthly payments.
  • Access to a lump sum of cash without altering your current mortgage.
  • Often used for specific large expenses, like home renovations, education, or debt consolidation.

Comparing Refinance and Home Equity Loan Options

Each option has unique features and considerations that might make one more suitable for your financial situation than the other. Below, we’ll break down the main factors to consider.

Interest Rates

  • Refinancing: 

When mortgage rates drop, refinancing can save you money by lowering the interest rate on your entire mortgage balance, leading to reduced monthly payments or faster equity buildup.

  • Home Equity Loan: 

These loans usually have fixed rates, which are generally higher than current mortgage rates but still competitive compared to other forms of credit like credit cards.

When to Choose: 

If you can lock in a lower interest rate for your main mortgage, refinancing may offer greater overall savings. However, if you’re satisfied with your current mortgage rate, a home equity loan may be preferable to avoid altering the terms of your original mortgage.

Loan Amount and Access to Cash

  • Refinancing (Cash-Out): 

With cash-out refinancing, you can access a substantial portion of your home’s equity, up to 80% of the property’s value in many cases, giving you more cash upfront.

  • Home Equity Loan: 

Typically allows you to borrow up to 80-85% of your home’s appraised value, minus any outstanding mortgage balance. This makes it a good option for a targeted, fixed sum of cash.

When to Choose: 

If you need a larger sum, especially for significant expenses like major renovations or debt consolidation, cash-out refinancing can offer greater borrowing potential. For smaller, defined expenses, a home equity loan provides flexibility without affecting your main mortgage.

Monthly Payments and Budget Impact

  • Refinancing: 

Refinancing may lower your monthly mortgage payments if you qualify for a lower interest rate or extend your loan term. However, adding cash out can increase the amount owed and possibly your monthly payment.

  • Home Equity Loan: 

Adds a second monthly payment. Since it’s a separate loan, it doesn’t reduce or alter your existing mortgage payments, which can be beneficial if you’re comfortable with your current mortgage.

When to Choose: 

If lowering your monthly payments is a top priority, refinancing is the more strategic choice, especially if you can reduce your interest rate. For those comfortable with their current mortgage payments and who want stable, separate payments for a fixed amount, a home equity loan may be more practical.

Loan Terms and Repayment Flexibility

  • Refinancing: 

Offers options to reset your mortgage term, typically 15 or 30 years, allowing you to potentially shorten or extend your payment timeline.

  • Home Equity Loan: 

Generally comes with shorter terms, often 5 to 20 years, which means higher monthly payments but potentially less interest paid over time.

When to Choose: 

If you’re looking to extend or shorten your mortgage term for better financial flexibility, refinancing offers this advantage. Home equity loans are ideal if you prefer a shorter repayment term and can handle the higher monthly payments.

Advantages and Disadvantages of Refinancing

Advantages:

  • Lower Interest Rates: 

If rates have dropped since your original loan, you could save significantly on interest.

  • Simplified Finances: 

A refinance is the simplification of your needs into one mortgage that also helps in eliminating some payments.

  • Potential to Shorten Loan Term: 

Refinancing is a good way to go for a shorter term loan and cut down the interest amount that you would pay on your mortgage.

Disadvantages:

  • Closing Costs: 

Refinancing entails closing costs that are usually between 2-5% of the loan amount meaning that any saving that is likely to accrue from refinancing may be overshadowed by the costs.

  • Longer Loan Term: 

If you stretch your loan to pay lower installments, you will end up paying more than the interest amount.

  • Risk of Increased Debt: 

Cash-out refinancing enhances your mortgage amount; this makes you have a bigger amount that you need to pay.

The Benefits and Flaws of a Home Equity Loan

Advantages:

  • Fixed Rates: 

Home equity loans have fixed interest rates and this makes their payment easy to plan for.

  • No Changes to Primary Mortgage: 

It allows you to retain your mortgage terms while allowing you to access funds.

  • Lower Costs for Shorter Terms: 

Closing costs of home equity loans are usually lower than those of refinancing.

Disadvantages:

  • Second Monthly Payment: 

Increases your expenses, which means it has an effect on your financial plan.

  • Higher Rates than Primary Mortgage: 

These may be higher than the current mortgage rates depending on the prevailing market.

  • Risk to Your Home: 

As with any mortgage, default means the lender can take the property and sell it to recoup their losses.

When to Choose Refinancing vs. a Home Equity Loan

Refinance if:

  • Current interest rates are significantly lower than your existing rate.
  • You want to lower your monthly payments or reduce the length of your mortgage.
  • You need a large amount of cash and are comfortable increasing your mortgage balance.

Home Equity Loan if:

  • You need a fixed amount of cash for a specific purpose.
  • You’re satisfied with your current mortgage terms and interest rate.
  • You prefer a fixed rate and a separate loan that won’t interfere with your primary mortgage.

Bottom Line

Choosing between refinancing and a home equity loan depends on your financial situation, goals, and current mortgage terms. Refinancing can be a smart choice if you’re looking to secure a lower interest rate, adjust your loan term, or access substantial equity for large expenses. On the other hand, a home equity loan may be more suitable for smaller, defined expenses without affecting your primary mortgage.

Reach out to Beach Community Mortgage today to discuss your refinancing and home equity options. We’ll help you find the best path to achieve your financial goals, keeping your home and future in focus.