What Kind of Loan Is Better, Refinancing or Home Equity?

Interest Rate

A homeowner with an existing mortgage should compare the rate on the existing loan with rates available for cash out refinance loans. If rates available on refinances are at least 1 percent below the existing mortgage rate, then it often makes sense to refinance even when you take into account closing costs. If home equity loan rates are comparable with mortgage rates and the refinance rates are equal to or higher than the current first mortgage, then the home equity loan probably offers the best option because these loans have minimal closing costs. Rate comparisons with variable rate home equity lines are not possible because the rates can change on a monthly basis; but when rates are very low, these loans are an attractive short-term option.

Lenders require surveys and full home appraisals for refinance loans, and this normally adds $700 or $800 onto the closing costs. Additionally, people with less than 20 percent equity have to buy private mortgage insurance which can add a few thousand dollars to the annual cost of a loan. Home equity products require neither PMI nor surveys, and lenders offer use inexpensive electronic appraisals rather than full appraisals. The underwriting process for a refinance takes between 45 and 60 days whereas home equity loans are often underwritten and approved within two weeks.

Term times are more flexible on home equity products than mortgages as borrowers can take out fixed loans with terms lasting between five and 30 years. Variable rate lines of credit, which work like credit cards, have terms starting at 10 years and some last as long as 35 years. Mortgage loans typically have 15- or 30-year terms although some lenders allow people to borrow for 10 or 20 years. Adjustable rate 15- and 30-year mortgages with interest only terms for the first five or 10 years are available for people who want to make minimal payments in the early years.

Borrowers should look at the total cost of the loan before choosing between a home equity loan and a refinance. Upfront closing costs are typically much higher for mortgages, but in the long term rates are lower which means lower principal and interest payments. The larger the loan amount, the more significant each 1/4 percent of interest becomes in terms of overall cost. Lenders can provide total cost comparisons of the loan options side by side to show borrowers the overall expense. Generally, home loans, due to minimal upfront costs, offer the best short-term option whereas someone planning to stay in a home for more than 10 or 15 years may eventually benefit from a low interest rate, cash out refinance.