There are several ways to finance a big home improvement project. One is to refinance for cash out, the other is to apply for a home equity loan or credit. Here is what you need to know:
What is Equity?
Equity is the portion of your mortgage that you have paid down. If you have a $250,000 mortgage and you’ve paid $50,000 of it so far, that’s one fifth or 20% of your home. This is known as the loan-to-value ratio.
What types of Home Equity Loan products are available?
There are two types of home equity loan products available. A cash out refinance is a fixed dollar amount that you borrow outright. The second is a Home Equity Line of Credit or HELOC. The HELOC allows you to withdraw small amounts of cash as needed from a fixed amount paying interest only on the amount of money you’ve used.
When should I consider a cash out refinance or HELOC?
These loans are intended for big projects. A minimum loan amount would be $10,000. The maximum depends again on how much equity you currently have.
First off, you can expect to find a better interest rate than you would on a credit card or other unsecured personal loan. Remember that a cash out refinance and a HELOC are both considered second mortgages and, as such, are available at either a fixed or adjustable rate.
Will I be expected to pay closing costs?
These types of loans generally do not have closing costs, but may have an application fee.
How should I choose between these two products?
As both are home mortgages they share one similar advantage. The interest on either may be tax deductible. Check with your tax advisor to be sure.
Are there disadvantages?
Again, because these types of loans are considered a second mortgage they can be foreclosed on should you default on your payments. In the event you do so, your primary mortgage would be paid from the proceeds of the sale of your home by the bank. Your Home Equity Loan or HELOC would be paid second.