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Cash Out Refinance to Pay Off Home Equity Loan

Pay Off Home Equity Loan

Cash out refinance to pay off home equity loan.

You may be evaluating if it would make good financial sense to refinance your existing mortgage, get cash out, and pay off your home equity loan. The answer is that it might, and it might not.  Here are some things to consider before making a decision.

What is a Home Equity Loan?

A home equity loan is a line of credit you can access based on your existing home equity. The structure and terms of your mortgage remain the same, and you get a loan that’s secured by your current home equity. The home equity loan is basically an installment loan that comes with its own terms, repayment schedule and interest rate. Unlike cash out refinancing, you must repay the home equity loan in full, in addition to making regular payments on your existing home mortgage.  Home equity loans are also called second mortgages, although if your current home mortgage is already fully paid off, you may be able to get a home equity loan that’s considered a first mortgage. When the home equity loan closes, you can receive the proceeds either in a lump sum or as a line of credit.

What Is Cash Out Refinancing?

Cash out refinancing is taking out a larger loan than your current loan balance and being awarded the difference at closing.   The new mortgage will be an entirely different loan with a new interest rate, new terms, and a shorter or longer repayment period.  The new loan is used to pay off your existing mortgage along with fees and closing costs. What’s left after that is all yours.

Here is a simple example of cash out refinancing:  You own a home worth $200,000, owe $100,000 on the mortgage, and have $100,000 in home equity. You want to use $20,000 of your home equity to pay off your home equity loan. You arrange a cash out refinance in the amount of $120,000. You use $100,000 of that amount to pay off your existing mortgage, and you get the $20,000 in a lump sum of cash to pay off your home equity loan.

What Are The Advantages Of Using Cash Out Refinancing To Pay Off A Home Equity Loan?

The biggest advantage of using cash out refinancing to pay off an existing home equity loan is that you can usually get a lower interest rate on the new mortgage than you are currently getting on your home equity loan. The interest rate on the new mortgage may also be lower that the interest rate on your existing mortgage. The bottom line is that if you get a lower interest rate on the new mortgage and pay off your existing home equity loan with the proceeds, you’ll get rid of the home equity loan, and you’ll save on interest for the duration of the new mortgage.

What Are The Disadvantages Of Using Cash Out Refinancing To Pay Off A Home Equity Loan?

The biggest disadvantage of using cash out refinancing to pay off a home equity loan is new loan fees.  Fortunately, we have low closing costs on our cash out refinances, but it is still important to factor all fees into the equation.  The closing costs can offset some of the savings that may be gained from a lower interest rate.  In many cases the savings will far outweigh the closing costs, but it is still important to scrutinize such details in every case.

Another consideration is that if you have had your current mortgage for a long time and are currently paying more in principal than in interest, you might save more in the long run if you keep your existing mortgage and pay off the home equity loan over time instead of doing a cash out refinance.

Finally, if you borrow over 80 percent of the present value of your home, you’ll have to purchase private mortgage insurance; this could raise your costs considerably.  We advise to stay under 80% LTV if you can make it work.

Do The Math To Determine Whether Cash Back Refinancing Would Be Right For You

Before you opt for a cash out refinance, it makes sense to do your homework. If you do the math, taking all variables into consideration, you will be able to see clearly whether getting a new mortgage and paying off your home equity loan would be a sound financial strategy for you.  We are also here to help and show you your potential savings.  We will also tell you if we do not believe it is in your best interest to refinance.

Can I Qualify For A Cash Out Refinance?

To qualify for a cash out refinance, you will need to have good or excellent credit.  In some cases, “fair credit” borrowers may qualify. You will also need to have owned your home for at least one year and have adequate equity to pull out.  Finally, you’ll need a maximum loan-to-value ratio of about 85 percent.

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