Home equity loan or cash-out refinance?

Posted by  on Sep 21, 2011

I want to add a deck to my home and need about $10,000. Is it better to get a home equity loan or should I refinance my mortgage and just add the extra $10,000 to the new loan?

In the past, I would have said that if current mortgage rates were low enough to make refinancing pay off, you should just choose the cash-out refinance. End of story.

Today, however, I wouldn't necessarily make that recommendation. Conventional (non-government) mortgages can come with pretty hefty add-ons to their pricing when you take cash out with your refinance. For example, if your credit score is 699 and your loan-to-value is 85 percent after refinancing, you'll get socked with an extra 2.5 points in loan fees to take cash out with a Fannie Mae or Freddie Mac loan. If refinancing a $200,000 mortgage, it would cost you $5,000 to borrow $10,000, or your mortgage rate quote would have to be increased to cover the extra fees. So refinancing your current mortgage might be a money-saving move, but taking cash out could negate that savings.

If your refinance is an FHA mortgage up to an 85 percent loan-to-value, it's a different picture. There are no add-ons, and in that case, if you can offset your refinancing costs with a lower mortgage rate it makes sense to take cash out in your refinance. You'll want to get three quotes from every lender you talk to:

  • Cash-out conventional refinance
  • Cash-out FHA refinance
  • Refinance with no cash-out (this is called a rate-and-term refi), plus a second mortgage

Second mortgages--either home equity loans or home equity lines of credit (HELOC)--come with very low costs. In most cases you're looking at an appraisal fee and some title charges totaling a few hundred dollars. Some lenders waive all the fees. What all this means is that one way or another you should be able to find inexpensive financing for your deck.



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