Refinancing vs. Home Equity Loan
Let’s expand our discussion on mortgage vs. home equity loan by throwing another option into the mix: refinancing.
Refinancing is similar to a home equity loan. In both cases, you’re banking on the equity you’ve built on your home as collateral. However, your reason for getting each loan is different.
A home equity loan essentially turns your house into an emergency source of cash. If you need money for big purchases, such as your child’s college education or remodeling your house, this is typically the route you’d take.
With refinancing, your goal is to trade your old mortgage for a new one with a lower interest rate. Say you took out a mortgage on your loan 15 years ago at an interest rate of 4.8%. Swapping for a new mortgage with a lending rate of 3.2% means you’ve lowered your interest by 1.6%, potentially saving you hundreds of dollars in monthly payments.
Refinancing Options
Most refinancing options come as one of two types:
- Rate-and-term
- Cash-out loan
A cash-out loan refinance works like a home equity loan in that you’ll receive enough money to finance other purchases. You’ll get funds to replace your old mortgage, and you’ll also get additional cash you can use to pay off your other debts such as student loans or car loans.
Rate-and-term refinancing, on the other hand, simply switches your old interest rate for a new one. You can only get back less than two thousand dollars in cash back, which is why it’s also called “no cash-out refinancing.”
The one potential drawback with refinancing is that it involves closing costs, typically around 2 – 3% of the loan amount. Thus, refinancing is best if you plan on staying in your home long enough for you to recover these costs (ideally 18 months or more).
Do you plan on staying in your home only for the short term but still want to cash in? Choose a home equity loan since it has fewer closing costs than refinancing.