Tappable home equity in the U.S., or the total amount available for homeowners to borrow against, is at $5.9 trillion, close to the all-time high. According to Black Knight, approximately 44 million homeowners have on average $136,000 of tappable equity. In this market, it might be a good time to think about using a home equity loan to refinance your first mortgage or your current home equity loan.
A big benefit of refinancing with a home equity loan is the lesser amount of cash needed to close the loan. Traditional refinancing can mean thousands of dollars in closing fees. “For homeowners looking to avoid the fees of a traditional mortgage refinance, a home equity loan may be an attractive option,” says Rob Cook, Head of Marketing and Customer Experience for Discover Home Equity Loans. “For instance, Discover Home Equity Loans offers financing with zero origination fees and zero cash due at closing.” Eliminating or lowering these closing costs can save you hundreds—if not thousands—of dollars.
Here are some other factors to think about when refinancing—such as new loan terms and lower monthly payments.
Know what equity you have
First things first. It’s time to calculate your available home equity: subtract the amount you owe on your home from its estimated current value. For example, if your home is valued at $200,000 and you owe $150,000, your home equity is $50,000. Next, estimate your loan-to-value (LTV)—which is the ratio of what you owe compared to your home’s current value. To get this number, subtract the equity in your home from its total value. Then, divide that number by your home’s total value. In the above example, you would divide $150,000 by $200,000 to get an LTV of 75 percent, or 25 percent home equity. (LTV only includes a primary mortgage in its calculation.)
Some lenders, like Discover Home Equity Loans, will lend up to 95 percent combined loan-to-value (CLTV), depending on your credit score. CLTV differs from LTV in that it includes all mortgages and liens on your property, not just the primary mortgage. This means that your total mortgage amount including all liens can go up to 95 percent of your home’s value. However, in general, it’s a good idea to keep your CLTV at 80 percent or less. Not only might other lenders look more favorably at your loan application, but you’ll also likely pay lower mortgage rates for your loan the more equity you have.1
Look at the advantages of a cash-out refinance
If you’ve built up more than 20 percent in home equity, you may be thinking about a cash-out refinance, which is a refinance of your primary mortgage for more than you owe. You get the difference in cash.
Having access to cash could be a good idea in case of emergency or a major life event, or maybe it’s time for that home improvement project. A remodel can be a good way to use cash because you are putting value back into the home. Another good option for a cash-out refinance is furthering your own education. Says Cook: “Education is, in essence, an investment in yourself, which can offer a good return in the form of increased income opportunities.”
Another reason to consider a cash-out refinance is if you can use it to lower the rate or reduce the term on your primary mortgage, as this strategy works to preserve your equity. However, you may be able to refinance your first lien with a home equity loan and avoid the fees.
There may be a surprise loophole to avoid the added cost of a cash-out loan and actually get some cash out of your refinance without penalty. It works by taking advantage of the overlap of funds at the end of one loan and the beginning of another—the cash that’s left in escrow. For instance, on a $200,000 loan, it’s possible to generate about $4,000 in cash under the right circumstances and with the help of your mortgage lender.2
When doing the research, compare all your options and think about your needs. When looking at a cash-out refinance vs. a home equity loan, compare the closing costs, interest rates and fees for both. Because they vary, each will have a different impact on your home equity and cash flow.3
Seek shorter terms
If you’re not taking cash out of your home but instead reassessing the terms of your loan, a refinance can still impact your home equity. While extending your loan payments to a new 30-year mortgage may help your cash flow, you could be slowing your progress to building your equity.4 Check to see if a 10-, 15-, or even a 20-year loan term might be affordable, which is a nice compromise, “because you’ll build equity faster with a shorter-term loan and you’ll pay less in interest over time,” says Cook. The key is figuring out what you can comfortably afford monthly.
And, don’t forget to compare closing cost options. See if you can negotiate lower fees or pay your closing costs in cash instead of financing them to preserve your home equity in every instance possible.
Take good care of the wealth in your home
Your home equity is valuable—and, as a homeowner, can make up a large piece of your net worth. That should be kept in mind as you consider the impact of tapping the wealth you’ve built in your home—and ways to preserve it.