Should I Refinance or Get A Home Equity Loan?

Should I Refinance or Get A Home Equity Loan?
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Interest Rates

People use their home equity to fund a lot of different projects including buying rental homes, installing swimming pools or just refurbishing a bathroom. If you are planning to take out a loan secured by your primarily home, before asking yourself “should I refinance or get a home equity loan?” you should look at interest rates.

Mortgage rates are based upon rates for 10-year Treasury bonds because on average, most mortgages are paid off in 10 years so bonds tied to mortgages have a similar duration to Treasury bonds and both are viewed as fairly conservative debt-secured investments. Home equity loan rates are typically based on the Wall Street Journal U.S. prime rate which follows the Federal Reserves overnight lending rate. The Federal Reserve change the overnight rate to counter inflation or deflation in the wider economy. Bond rates rise and fall based upon supply and demand so the rates of mortgages and home equity loans often move in opposite directions. If you had a 30 year mortgage for $165,000 with a 4.75 percent interest rate, the monthly principal and interest payment would be $860. If you raise the rate by 1 percent, the payment increases to $962 which equates to an extra $36,720 over the course of the loan. If mortgage rates are lower than home equity loans or vice versa then you should calculate your monthly savings as well as your long term rate savings before making a decision. Home equity loans tend to have more term options than mortgages as home equity loans are available with terms ranging from 5 to 30 years whereas mortgages typically have terms lasting between 15 and 30 years. Shorter terms usually have lower interest rates so if you can afford the higher monthly payments that may give the home equity product the edge.

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Closing Costs

Banks do not generally sell home equity loans on the secondary market and as a consequence, the loans do not necessitate a full appraisal, a survey, or mortgage premium insurance. This means home equity loans have much lower closing costs than mortgages because these are elements of mortgages and all mortgages that exceed 80 percent of a home’s value require monthly mortgage insurance premiums.

If you refinance your first mortgage to extract equity, you must take out a cash out refinance loan and typically cash out refinance loans have higher rates than straight refinances that do not involve anything other than paying off the first mortgage. The refinance may cause your interest rate on your existing balance to rise if you currently have a low rate. Additionally, most mortgages require the owner to pay an origination fee equal to 1 percent of the loan amount. On a $165,000 mortgage that means an extra $1,650 of closing costs whereas home equity loans typically do not have such a fee. This fee in conjunction with the other mortgage closing costs means that mortgage closing costs are far higher than the fees associated with a home equity loan. If the mortgage rate is lower than the home equity rate, deduct the closing costs from the overall long-term interest rate savings to determine which product offers the best overall deal. If you do not plan to stay in the house for long, you probably will not recoup closing costs and you should go with the loan that has the lowest out of pocket expenses. Shop around for the best rates and the lowest closing costs and once you have done your homework you will be able to answer “should I refinance or get a home equity loan?” all by yourself.


Bankrate: Refinance Vs Home equity Loans -