Finance Industry News

Yet, there are ways for a homeowner to tap into the home’s equity should the time come when he or she will need cash for one reason or another.

There are many different reason’s why a homeowner may choose to tap into the equity of their home, including:

• To help pay for college tuition
• To consolidate debts
• To help pay for home renovation
• To fund a major purchase
• To pay off an urgent debt
• To pay for travel expenses

If a homeowner goes to a bank to borrow against their home’s equity, they may be given a choice of refinancing the existing mortgage, applying for a home equity loan, or applying for a home equity line of credit. Here are some pros and cons or each type of financing.

Refinanced mortgage: Pros and cons

Also known as cash-out refinancing, this option works by taking out a new loan and executing a new mortgage for a larger amount than the old loan, and then paying off the old mortgage.

The loan proceeds are first applied to retire the old loan and the homeowner receives what’s left for use elsewhere. One advantage of this type of equity financing is the potential savngs attached to a lower interest rate that you may be able to secure.

The disadvantages include the possible extended term of the mortagge loan and the increased amount of monthly amortizations. Because the borrower now owes the bank a larger amount than before, she have to pay more and, at the same time, it may take her longer to fully pay off her mortgage.

Home equity loans: Pros and cons

In mortgage refinancing, the old loan is paid off and superseded by the new loan. With a home equity loan, the old mortgage is maintained and the new loan is secured by a second mortgage on the same property, specifically on the equity portion of a home.

On the upside, home equity loans can often carry lower interest rates than non-secured loans and a homeowner can use the proceeds of the new loan any way he sees fit.

On the downside, the borrower risks losing his home if he fails to meet the monthly payments and the bank forecloses on his property.

Home equity lines of credit: Pros and cons

The third type of equity financing is the home equity line of credit, a revolving line of credit against which a homeowner can borrow anytime she wishes as long as her total outstanding loan balance stays within the approved maximum amount. It is also secured by her home equity.

This is in contrast to the first two types of equity financing that are both lump sum releases. The advantage one gets from home equity line of credit is the extreme flexibility it offers.

This option allows the borrower to draw funds on demand. It may also allows the borrower to pay only the interest on the current outstanding loan amount. However, home equity lines of credit carry a variable interest rates and, in cases where the market rate is on the uptrend, the borrower will also end up paying higher interest.

Compare all options

Even before considering your options, it is best to decide whether it is even worthwhile to tap into the equity of your home for your cause (See also: Five things a home equity loan should not be used for). If you determine that tapping into your home’s equity is the best course of action, consider all of the pros and cons of each type of equity financing before deciding on the right choice for you.