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Should You Refinance Your Mortgage or Get a Home Equity Loan?

Should You Refinance Your Mortgage or Get a Home Equity Loan?

Michael Jensen, Mortgage and Finance Guru
, Mortgage and Finance Guru
  • Options for Borrowers to Access the Equity in a Property
  • A cash-out refinance and debt consolidation refinance are ways for borrowers to access the equity in their property. A home equity loan or line of credit are other options for borrowers to take money out of their property without refinancing their current mortgage.  There are multiple factors borrowers should consider when deciding between refinancing their mortgage or taking out a smaller home equity loan or line of credit.  In many cases a home equity loan or line of credit credit can save the borrower on upfront closing costs and total interest expense over the life of the loan.  Below, we outline the positives and negatives for each home financing approach and review examples that demonstrate when each option makes financial sense for borrowers.

    There are pros and cons to both financing options and the right answer depends on the borrower’s financial situation and objectives.  The key factors that determine if it makes sense to refinance or use a home equity loan or line of credit are the length of time you have been paying down your existing mortgage as, your mortgage rate and the terms for and home equity loan or line of credit.  Closing costs are typically lower with a home equity loan or line of credit which is an added benefit but that should not be the determining factor in deciding what financing option is right for you.

    In many situations it it makes more financial sense to obtain a home equity loan or line of credit instead of refinancing your mortgage.  Unless you are able to reduce your mortgage rate and loan term for by refinancing, it typically makes more sense for borrowers to select a home equity loan or line of credit, as long as you can access the amount of money you need.

    This is because by refinancing your existing mortgage, unless you reduce the term of the new mortgage, you are basically starting over paying back the original loan, which costs you thousands of dollars more in interest expense. For example, if you are ten years into a $200,000 30 year mortgage and you refinance with a new $200,000 30 year loan you have essentially converted your original 30 year loan into a 40 year mortgage, which means you pay significantly more in total interest over the life of the loan. The longer your mortgage, the more interest expense you pay.

    By comparison, the loan amount for a home equity loan or home equity line of credit (HELOC) is smaller than a new mortgage plus your loan term may be shorter. For example you may be able to arrange a 10 to 20 year home equity loan. The smaller loan amount and shorter loan term combine to significantly reduce how much total interest you pay as compared to refinancing your mortgage.

    The table below compares loan and program terms for home equity loans and HELOCs.  The initial teaser rate for a HELOC is usually lower than for a refinance but home equity loan rates are higher.  The interest rate for a HELOC increases after the introductory period while rates for a home equity loan and refinance remain the same if you select a fixed rate loan prorgram.  We recommend that you contact multiple lenders to review loan proposals so you can determine if a home equity loan, HELOC or refinance is the right option for you.

  • %
    Current Home Equity Loan Rates as of January 23, 2019
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details.
  • While a home equity loan or HELOC offer significant financial benefits as compared to refinancing, there are several situations when refinancing is the better option.  First, if you are able to reduce your mortgage rate when you refinance that can lower your monthly payment and save you a significant amount of money.  If you can lower your rate by at least .750% then it usually makes sense to refinance.

    Second, if you can shorten the length of your mortgage then refinancing is an attractive alternative. Reducing your mortgage length, such as refinancing a 30 year loan with a 20 year loan, enables you to avoid extending the term of your loan and lowers your total interest expense. Another reason why a refinance is preferred to a home equity loan or HELOC is if you want to change mortgage programs. For example, if you have an adjustable rate mortgage, you may want to refinance into a fixed rate loan for greater certainty.

  • CalculatorUse our CASH-OUT REFINANCE CALCULATOR to determine if it makes sense to refinance your mortgage or use a home equity loan
  • The final case when refinancing is preferred over a home equity loan is if you want to take a significant amount of money out of your home. A home equity loan or HELOC may apply a maximum loan amount and you may be able to access more equity in your home with a cash-out refinance. In short, there are multiple cases when a refinance is a better financing option than a home equity loan, depending on your current mortgage terms and financial objectives.

    The table below shows refinance rates and closing costs for leading lenders in your area.  We recommend that you shop multiple lenders to find the best refinance terms. Comparing multiple loan quotes is the best way to save money when you refinance your mortgage.

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    Current Refinance Mortgage Rates as of January 23, 2019
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click here for more information on rates and product details.
  • Example Comparing a Refinance to a Home Equity Loan
  • The examples below show different scenarios for comparing refinancing to a home equity loan.  The examples compare the mortgage payment, total interest expense and total debt payments for multiple refinance and home equity loan scenarios, including different mortgage rates and loan terms.

    As demonstrated by Example #1, when comparing a refinancing to keeping your original mortgage and using a home equity loan there may be a trade-off between having a higher monthly payment for a set number of years (10 to 15 years for a home equity loan) and paying less in total interest over the life of the mortgage.  If you can afford the higher monthly payment for a set number of years it typically makes more sense and saves you money in total interest expense over the long term to keep your current mortgage in place and obtain a home equity loan or line of credit.

    In an ideal scenario presented in Example #2, you are able to reduce your mortgage rate and term by refinancing, enabling you to lower your monthly mortgage payment, reduce your total interest expense over the life of the mortgage and access the equity in your property. Otherwise, if you can afford the higher monthly payment for a set number of years it typically makes more sense and saves you money in total interest expense over the long term to keep your current mortgage in place and obtain a home equity loan or line of credit.

    Review the detailed examples below to understand the financing option that best meets your personal and financial objectives.

    Use the FREEandCLEAR Lender Directory to search for twenty-five mortgage programs including home equity loans and refinance options.

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  • Example 1: Comparing a Home Equity Loan to a Refinance with No Reduction in Interest Rate or Term
  • The example below demonstrates how a home equity loan can save you hundreds of thousands of dollars in total interest expense as compared to a refinancing.  In this example the borrower is ten years into the original $300,000 mortgage and wants to access $50,000 in property equity for a major purchase.  The example compares two scenarios for accessing equity in a property: a home equity loan and a cash-out refinance.  In the refinance scenario, the borrower does not reduce his or her term or mortgage rate by refinancing and replaces the original 30 year $300,000 mortgage with a new 30 year $300,000 loan.

    • Scenario 1: The borrower uses a 15 year $50,000 home equity loan and keeps the original mortgage in place
    • Scenario 2: The borrower uses a cash-out refinancing to access $50,000

    As demonstrated by this example, because the borrower does not reduce his or her mortgage term or interest rate by refinancing, the cash-out refinance costs the borrower thousands more in total interest expense when you combine the original and new mortgages.  When you add the interest expense from the first ten years of the original mortgage to the new refinanced mortgage, the borrower spends $111,250 more in total interest expense as compared to keeping the original mortgage and taking out a home equity loan.

    This is because the cash-out refinance effectively extends the term of the original mortgage by 10 years (so the borrower makes 10 extra years of mortgage payments in Scenario 2). The total interest expense is greater in the refinancing scenario even though the interest rate on the new mortgage is less than the rate on the home equity loan.

  • Great Mortgage IdeaIf you are unable to reduce your interest rate or term by refinancing then a home equity loan or line of credit usually makes more financial sense
  • Scenario 1: Original Mortgage
    Plus Home Equity Loan

    Original
    Mortgage
    Home Equity Loan Total
    Loan Amount $300,000 $50,000
    Term 30 years 15 years
    Current Principal Balance $244,000 $50,000
    Interest Rate 5.00% 6.00%
    Monthly Payment $1,610 $422 $2,032
    Total Interest Expense $279,600 $25,950 $305,550

    Scenario 2: Cash-Out Refinancing
    No Reduced Term or Interest Rate

    Cash Out
    Refinancing
    First 10 Years of
    Original Mortgage
    Total
    Loan Amount $300,000
    Term 30 years
    Current Principal Balance $300,000
    Interest Rate 5.00%
    Monthly Payment $1,610 $1,610
    Total Interest Expense $279,600 $137,200 $416,800
    Total Interest Expense Savings / (Cost) ($111,250)
  • Example 2: Comparing a Home Equity Loan to a Refinance with a Reduction in Interest Rate or Term
  • The second example below demonstrates how a refinancing can save you thousands of dollars in total interest expense as compared to keeping your original mortgage and obtaining a home equity loan if you are able to reduce your mortgage rate and shorten your term when you refinance.  In this example the borrower is ten years into the original $300,000 mortgage and wants $50,000 for a major purchase.  This example also compares two scenarios for accessing equity in a property: a home equity loan and a cash-out refinance.  In this example, however, in the refinance scenario the borrower replaces the original 30 year $300,000 mortgage with a 5.00% interest rate with a new 20 year $300,000 mortgage with a 4.00% interest rate.

    • Scenario 1: The borrower uses a 15 year $50,000 home equity loan and keeps the original mortgage in place
    • Scenario 2: The borrower uses a cash-out refinance to access $50,000 and reduces both the interest rate and term of the mortgage

    As demonstrated by this example, because the borrower reduces his or her loan term and mortgage rate, refinancing saves the borrower thousands in total interest expense.  When you add the interest expense from the first ten years of the original mortgage to the new refinanced mortgage, the borrower saves $32,050 in total interest expense as compared to keeping the original mortgage and taking out a home equity loan.

    Because the mortgage term was reduced from 30 years to 20 years, the borrower’s monthly payment increases from $1,610 to $1,818 with the new refinanced mortgage even though the loan amount stayed the same and the mortgage rate decreased.  The shorter the term, the higher the monthly payment but the lower the total interest expense over the life of the mortgage.  Despite the increase, the new monthly mortgage payment of $1,818 is less than the $2,032 combined monthly payment of the original mortgage ($1,610) and the home equity loan ($422).

  • Great Mortgage IdeaIf you are also able to reduce your interest rate and term, refinancing can save you money in total interest expense as compared to a home equity loan
  • Scenario 1: Original Mortgage
    Plus Home Equity Loan

    Original
    Mortgage
    Home Equity Loan Total
    Loan Amount $300,000 $50,000
    Term 30 years 15 years
    Current Principal Balance $244,000 $50,000
    Interest Rate 5.00% 6.00%
    Monthly Payment $1,610 $422 $2,032
    Total Interest Expense $279,600 $25,950 $305,550

    Scenario 2: Cash-Out Refinancing
    Reduced Term AND Interest Rate

    Cash Out
    Refinancing
    First 10 Years of
    Original Mortgage
    Total
    Loan Amount $300,000
    Term 20 years
    Current Principal Balance $244,000
    Interest Rate 4.00%
    Monthly Payment $1,818 $1,818
    Total Interest Expense $136,300 $137,200 $273,500
    Total Interest Expense Savings / (Cost) $32,050
  • Great Mortgage IdeaRelated FREEandCLEAR Resources

  • Sources

    Refinance and Home Equity Loan: https://www.consumerfinance.gov/ask-cfpb/does-a-heloc-affect-my-ability-to-refinance-my-first-mortgage-loan-en-252/

About the author

Michael Jensen, Mortgage and Finance Guru

Michael is the co-founder of FREEandCLEAR. Michael possesses extensive knowledge about mortgages and finance and has been writing about mortgages for nearly a decade. His work has been featured in leading national and industry publications. More about Michael

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