If you have equity in your home, you can apply for a home equity loan at the same time as you refinance. If you anticipate needing some extra cash, either now or down the road, getting a home equity loan (also known as a second mortgage) when you refinance saves you time and money, as well as the stress of going through the financing process twice. Most lenders do not charge any additional fees when you apply for a home equity loan concurrently with a refinance.
Term Loans and Lines of Credit
There are two types of second mortgages: term equity loans and lines of credit. Suppose you got a second mortgage for $20,000. With a term loan, the lender would give you the full amount at closing, and you would pay it back with regular payments over a set period of time, usually 10 or 15 years. In that sense it works the same as a first mortgage loan. With a home equity line of credit (HELOC) you have the ability to draw any amount from zero up through the full $20,000. You only pay interest on what you actually use. HELOC payments are interest-only for a set period of time, usually 5 or 10 years, after which you will need to make principal and interest payments on whatever balance remains.
Lines of Credit Offer Flexibility
A HELOC makes funds available to you should you need them at a later date, but with no current obligation or cost. Some people never use their HELOCs. But if a major unforeseen cost arises -- perhaps the need for a new roof, or an easement against your property -- you will have low-cost funds available to draw on.
Term Loans for Immediate Needs
If you are in need of funds right away, it's typical to simply change your refinance into a cash-out loan, thus wrapping everything into a single payment. But a term equity loan might also make sense. For example, if you anticipate receiving a large amount of cash in six months or a year, but need funds now, it would be smart to get a second mortgage when you refinance. Then you can pay off the equity loan and only be left with the payment on your first mortgage. If you are considering this, be sure to negotiate with your lender for a home equity loan with no prepayment penalty.
Second Mortgages Require Equity
Home equity loans and lines of credit require substantial equity for qualification. Some lenders only lend on an equity loan up to a combined loan-to-value ratio of 80 percent, while some will go up to 90 percent. If you do have equity in your home, these loans can be a great, low-cost source of funds for a variety of needs.
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