The housing market is coming back, which means you might find yourself with more equity in your home soon, if you have not already. While this is good news, you should use caution before you take out a
cash-out refinance. It can be tempting to use your equity to consolidate your existing debt or make major changes to your home, but there are a few things you should consider. The housing crisis occurred because of mortgages made in haste. If you want to prevent ever having to go through that experience again, you may want to think twice before taking cash out of your home.
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Should you Refinance or Take out a Home Equity Loan?
The first consideration should be whether or not you want to touch your first mortgage. If you have a good rate locked in with your first loan, you might not want to touch it. This is especially true if you were able to take advantage of the extra low rates that were available in the last year. If this is the case for you, a home equity loan might be a better option to get the cash you need out of the equity of your home. When you leave your first mortgagee untouched, you are able to keep your low rate and affordable payments. A home equity line of credit generally has low rates and allows you to only use the portion of your line of credit that you need at that time. If you do not need the entire amount, you can leave the principal untouched and not have to worry about paying interest on money that you did not need in the first place.
How Long Have you had your Loan?
Your current loan plays an important role in your decision to do a cash-out refinance. If you have held your primary mortgage for several years, you might want to think about refinancing as it will reset your term all over again. If you have already paid 5-10 years on your mortgage, do you really want to reset it back to square one, making 30 years of payments all over again? An alternative would be to take out a home equity loan. The average HELOC has a term of 20 years with a 10 year draw period. This means you will have your loan paid off quicker than you would had you refinanced your first mortgage into another 30-year term. The 10-year draw period means you are able to draw the funds you need from the line of credit for the first 10 years of the loan. After the 10 years, you are in the repayment period of the loan and will be unable to touch the line of credit any longer.
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What is your Reason for a Cash-Out Refinance?
The equity in your home should be guarded carefully. It is not there simply to get you out of debt every time things get out of hand. Give careful consideration to your reason for wanting a cash-out refinance. Is it to make major improvements to your home? If this is the case, you should do your homework to determine the effect the improvements will have on your home. If they will greatly increase the value of your home, then the cash-out refi is likely worth it. On the other hand, if you are taking the equity out of your home to cancel out credit card debt or student loans, you might want to think long and hard about what you are doing. Getting rid of some debt might make you feel better, but in the long run, it will make it very difficult to get the equity back in your home. In this case, a HELOC might be a better choice as it can help to pay off your debts without touching the progress you have made on your 1st mortgage payments.
What Type of Payment can you Afford?
The payments on a regular mortgage and HELOC greatly differ. If you take the equity out of your home with a 1st mortgage, you will have to pay principal and interest payments like you do now. The difference is your payment will be higher because of the higher loan amount. If you take out a HELOC, you will only be responsible for the interest portion of the payment every month during the draw period of the loan. During this time you are free to make principal payments, but you are not required, which means it does not count against you if you only make interest payments. Of course, this does not help you to earn the equity back in your home, but it can be beneficial financially if you are unable to pay more than the interest payments.
Before you take out a cash-out refinance, think long and hard about why you are doing it and what you can afford. There are several ways to get the money out of your home if you need it, but the implications of the method can greatly alter your mortgage for the next 30 years. You want to make sure you are making the decision that is right for you to ensure that you are able to keep your home and readily get yourself out of debt or make the home improvements that you desire.
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