Just last year home values erased the equity deficit and surpassed the highest median home value set in 2006. Here in San Diego County we’re certainly no different and that means a return to the home equity loan marketplace. Homeowner equity is simply the difference between the current market value of the property and the outstanding loan balance, less associated closing costs. The difference is the equity that belongs to the owner. How do you become eligible to pull equity out of your property?
The most common way is to simply sell the home. During a sale, the old loan is paid off and closing costs, including real estate commissions are deducted from the sales price and the net proceeds are delivered to the homeowner. However, for someone who just wants to tap into the equity of an existing home without the somewhat drastic measure as an outright sale, there are other, more agreeable options.
A cash out refinance is an option. A cash out refinance replaces an existing mortgage with a new one and during the process the borrowers pull out additional equity in the form of cash. For example, there is an existing loan balance of $300,000 and the owner wants to refinance to a lower rate. An appraisal is ordered and the result is a current market value of $550,000. If closing costs add up to $5,000 and the owner wants an additional $15,000 to pay off some student loans, the transaction would look something like-
Loan Amount $350,000
Payoff ($300,000)
Closing Costs ( $5,000)
Net Proceeds $15,000
It’s important to notice here the closing costs involved. The borrower did pull out $15,000 in cash but there is also $5,000 in closing costs, making the cash out a rather expensive proposition. Because of these costs when the only motivation is to tap into the equity of the home other less expensive options should be reviewed.
An equity loan has closing costs but not as many as a cash out refinance. An equity loan is a single mortgage where the funds are issued in one lump sum. The equity loan is in a subordinated position to a first lien and will have slightly higher rates compared to a loan in first position.
A home equity line of credit, or a HELOC, acts much like a credit card in that there is a maximum amount that can be borrowed and the balance can rise and fall based upon withdrawals and repayments made to the HELOC. For example, a HELOC lender can issue a HELOC with a maximum line of credit of $50,000. The borrowers can then tap into the line of credit when needed and repay it over time, all at once or pay a little extra each month in addition to the minimum amount required.
Which is the best option? If refinancing your current mortgage makes sense regardless of any cash out then a cash out loan might be your best option. A line of credit can provide a lump sum payment to you and can offer either fixed or adjustable rate options. A HELOC provides the most convenience, is less expensive and can be used over and over again. It’s up to you and your loan officer to review the program that best suits your needs.
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