What's the Difference Between a Home Equity Loan and a Refinance?

The amount of equity you have will assist you in selecting the finest alternative.

As you build equity in your house, you’ll have more financial options as you pay down your mortgage. House equity loans and refinancing are two ways to extract cash from your home.

However, the two are not the same. While both of these financial instruments rely on the equity you’ve accumulated in your house, that’s where the similarities end. Home equity loans and refinances are vastly different possibilities in terms of how they’re used and when they’re utilized, as well as how much they cost. Each has its own set of benefits, drawbacks, and optimal uses.

What’s the Difference Between a Refinance and a Home Equity Loan?

Home Equity Loans

  • A second loan
  • Interest rates that are higher
  • Qualification is more difficult.

Refinance

  • The current mortgage is being replaced.
  • Interest rates are lower.
  • Qualification is easier.

 The Mortgage Situation

Property equity loans allow you to borrow against the value of your home. You can use the funds to cover house repairs and renovations, college tuition, medical costs, and other expenses. A home equity loan is essentially a second, smaller mortgage. 

Let’s imagine your house is worth $200,000 and you want to sell it. You still owe $180,000 on your mortgage. Your home equity is the difference between the value of your home and the amount owed on your mortgage ($70,000). You could use a home equity loan to get a portion of the $70,000 all at once.

The amount of a home equity loan is frequently limited to less than the amount of equity you’ve established in your property. It’s usually around 80% of your home’s equity. If you have $70,000 in equity in your house, you may only be able to get a $56,000 home equity loan. Your salary, credit score, and other financial circumstances all play a role. 

A refinance, unlike a home equity loan, is not a second mortgage. Instead, it takes the place of your current mortgage loan. Refinancing into a longer-term loan or one with a lower interest rate can result in a cheaper monthly payment and less interest over time. You can also refinance to go from an adjustable rate to a fixed-rate mortgage, which will help you lock in a cheaper rate over time. 

A cash-out refinance differs from a traditional refinance in that it allows you to tap into some of your home’s equity by taking out a loan that is higher than your present balance.

Let’s imagine your house is worth $250,000 and you still owe $180,000 on your mortgage. You may take that $180,000 and spread it out over a new 30-year period with a conventional refinance, perhaps lowering your monthly payment.

A cash-out refinance allows you to tap into some of that $70,000 in equity by refinancing into a new loan that’s greater than your present one. You’d get a lump sum of $50,000 ($230,000 minus $180,000) if you refinanced into a $230,000 loan.

You might wish to use your refinance to consolidate higher-interest debt in some instances. If you have a significant credit card or other loan balances, you can pay them off with your refinanced mortgage by rolling the sums into your loan balance and spreading the repayment costs out over time. A cash-out refinance could save you a lot of money in interest over time because mortgages typically have lower interest rates than credit cards and auto loans.

 Costs

Because they are second-lien loans, home equity loans have higher interest rates than mortgages or refinance loans. If you default on your payment, your primary mortgage lender has first claim to the property, not your home equity lender. As a result, home equity loans carry a higher risk. As a result, higher interest rates provide further protection to lenders. 

Even if you pay a higher interest rate, some home equity loan lenders will eliminate all or part of the closing charges.

 Qualifying

Because refinance loans are first-lien loans, they are often easier to qualify for. If you default on your loan, the lender will have the first claim on the property. Though refinancing frequently has a lower interest rate than a home equity loan, it will not always be lower than your present loan. Current average interest rates can be found at Freddie Mac. 

Also, check to see if there is a prepayment penalty on your present mortgage. You may need to pay it before refinancing if there is one. If you refinance with your current mortgage servicer rather than a new provider, see if the cost can be avoided.

 What Are Home Equity Loans and How Do They Work?

Home equity loans function similarly to first mortgages because they are really second mortgages. You’ll pick a lender, complete an application, send in your paperwork, wait for approval, and then close on the loan. You’ll receive a lump-sum payment for the amount of your loan, which you’ll repay month-to-month, just like your original mortgage.

 What Is the Process of Refinancing?

You won’t get a second mortgage payment because a refinance replaces your existing mortgage loan, but your current payment will change. Your payment could be greater or lower than your current mortgage depending on the interest rate you qualify for, the term of the loan you choose, and the amount you borrow.

 Refinancing or applying for a home equity loan

For both a home equity loan and a refinance, you’ll need to furnish a lot of financial and personal information, just like on any other mortgage application. W-2 statements, proof of employment history, your Social Security number, and other documents are frequently included. You may also need your most recent mortgage statement, proof of how much your house is worth, proof that there are no liens on it, and other documents.

 Final Thoughts

Home equity loans and refinances can both be beneficial financially. To figure out which choice is ideal for your family, consider your overall home equity, as well as your goals, preferred repayment time frame, and how long you want to stay in the house.

 Regardless of which path you take, check around for the best rate, as rates and closing expenses can differ significantly from one lender to the next.

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