Shopping for a Home Equity Loan
Cash-out Refinancing
Cash-out refinancing allows you to access equity in your home by
taking out a new mortgage that is greater than your old mortgage.
The new mortgage is used to pay off your old mortgage and the difference
between the two is your home equity loan.
Since you are replacing your first mortgage with a new one, cash-out
refinancing only makes sense when the refinancing interest rate
available to you is lower than your current mortgage. The lower
interest rate in refinancing will lower your monthly payments on
your mortgage. Since there are closing costs associated with refinancing,
you should only refinance if the savings on your lower monthly payments
can recover the closing costs before you sell your home.
Lets say your closing costs for refinancing were $3,000. The refinancing
deal gives you a lower interest rate that lowers your monthly mortgage
payments by $150. This means that you must stay at least 20 months
in your home to recover the refinancing costs ($20 months * $150
a month in savings = $3,000 refinancing cost). After that time,
you have recovered your costs and you are saving money.
Since cash-out refinancing is a first mortgage, it typically has
a lower interest rate than a home equity loan which is also a second
mortgage. Cash-out refinancing takes longer to process than does
a home equity loan.
If cash-out refinancing raises your loan-to-value ratio above 80%,
you will be required to pay private mortgage insurance, or PMI.
PMI protects the lender if you default on your loan - PMI does nothing
for you. PMI costs must be considered when cash-out refinancing
has an LTV that is more than 80%.
When you are considering cash-out refinancing, ask about escrow
services. The loan's monthly payments may or may not include an
escrow amount for property taxes and homeowners insurance. If an
escrow amount is not included, you will need to budget for those
costs separately.
While the cash-out refinancing is generally available to any homeowner
that has built up equity in their home, your first mortgage may
have a prepayment penalty clause that does not make refinancing
a viable option.
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