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Three Options to Access the Equity in Your Home

Image Stating "3 Options for Home Equity" on notepad with wood pieces making a house. Pen, coffee cup, laptop, and magnifying glass on table.

Whether you want to remodel your kitchen, put a new roof on your home, consolidate outstanding bills, or pay for your son’s college tuition, you could be wondering what is the best way to access the equity in your home to pay for your project?  There are primarily three options available to you when it comes to accessing the equity in your home. 

Refinance Your First Mortgage and Take Out Equity

When rates on first mortgages dropped significantly about 10 years ago, and continued to drop after that, this option became very popular.  People would refinance their first mortgage into a lower rate and at the same time would take out cash to pay for various needs.  Providers of first mortgages typically charge a slightly higher rate if you are taking equity out of your home when you refinance, but since the rates were so low, this option still offered quite a bargain. 

However, interest rates have been on the rise lately, and now if you want to access the equity in your home through refinancing your first mortgage, you will likely be paying a higher rate on your new mortgage than your current interest rate.  This means you will be paying a higher rate on your entire mortgage not just the portion of the equity that you want to tap.  Therefore, the current environment has made this strategy less enticing than it was just a couple of years ago.  However, it still is an option to consider.  Remember, when you utilize this option you might be choosing to refinance your debt for an additional 30 years, and that can be quite costly. Also, closing costs are based on the whole mortgage amount, so can be significantly higher than costs on a second mortgage.

Take Out a Home Equity Line of Credit

This strategy allows you to access the equity in your home, but gives you the option of determining when you need to access the equity.  Therefore, you only pay interest on the amount you need at any particular time, which can save you significant money as compared to borrowing a large sum of money at one time before you are ready to spend it.  These loans typically have a variable interest rate.  The initial interest rate can be quite low, but your future interest rate could change based on factors beyond your control.

This option may be best for you if you are not going to be taking out the loan proceeds all at once, but over a longer period of time and/or you are willing to take a chance on the future direction of interest rates.  Remember that the payments on home equity lines of credit also increase when interest rates increase.   Typically, these loans are paid back in 15 years, so the payments might be higher than financing your debt over 30 years, but you will likely save interest by paying your loan back faster.

Utilize a Fixed Rate Home Equity Loan

This option allows you to keep the low rate you have on your current first mortgage and borrow the money that you need from the equity in your home at a fixed rate. The rate will likely be higher than the initial rate on a home equity line of credit, and will also likely be higher than the rate you could obtain if you refinanced your entire mortgage.  However, the interest rate on this loan is fixed and you only pay the higher rate on the equity you are accessing.  Typically, these loans are paid back in 15 years.

To mathematically determine whether this option results in “overall” lower interest rate than refinancing your entire mortgage, you must calculate the weighted average interest rate on your first mortgage and new home equity loan and compared that to the interest rate you could obtain by refinancing your entire mortgage.  To calculate the weighted average rate on your current first mortgage and a fixed rate home equity loan, you multiply the rate of your first mortgage by the principal balance of that mortgage and add that to the rate you will pay on your new home equity loan multiplied by the principal you have on the new loan and then divide that amount by the combined balances of both mortgages.  If you determine that the weighted average interest rate would be lower than what you can obtain by refinancing your entire mortgage and taking out the equity you need, then this should save you money on interest in the long-run.

Get More Information

If you need more information on the options mentioned above or if calculating a weighted average interest rate causes your head to spin, let the experts at FedFinancial Federal Credit Union help you.  To contact a member of the FedFinancial team, you can email us or call 301-881-5626.  Just tell us that you want to determine the best way to access your home’s equity and we will provide you with all the information you need to make the decision that’s right for you.    

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