From the WSJ Real Estate Archives

Why You Can Afford
To Raid Your Equity

by Sarah Breckenridge

From SmartMoney

Jan. 31, 2002 -- It's Murphy's Law at work. Just when you need some serious cash, all the usual sources have dried up. Your salary is frozen. Your stock portfolio lost 20% last year. And that annual bonus? Forget about it!

But take heart. You do have one investment that has done well. In two years, the average home has appreciated 18%, and the typical homeowner now has $50,000 in equity. That makes your house the one lockbox you can still afford to raid. In last year's refinancing boom, the hot ticket was a "cash-out refi" -- you replace the old mortgage with a larger one, and pocket the difference. Other options are a home-equity loan or line of credit (aka second mortgage). Let's compare the costs and benefits.

  • Cash-Out Refinancing

Best for: People who haven't yet refinanced and could still lower the interest rate on their mortgage, or those who need more than $30,000. The 15- to 30-year term gives you more time to repay than the shorter term you get on a home-equity loan.

Costs: Interest rates can be half a percentage point higher than the regular advertised "refinancing" rate. And if you borrow more than 75% of your home's value, many lenders add another quarter point. There are closing costs -- usually a couple of thousand dollars on a $100,000 loan. But it's increasingly common to negotiate "no-cost" loans, in which those fees are added directly to the mortgage balance or absorbed by bumping up the rate.

Tip: Lenders require you to buy private mortgage insurance -- from 0.3% to 1.1% -- if you borrow more than 80% of your home's value. You may save money by covering up to 80% with your new mortgage and getting the rest with a home-equity loan; to find out, crunch the numbers at www.decisionaide.com.

  • Home-Equity Loan

Best for: Homeowners who already have a competitive interest rate on their mortgage and whose cash needs are lower. The most common terms for equity loans are between five and 15 years. It is possible to stretch it out, but if you need more time, a refinanced mortgage may be a better deal.

Costs: Interest on home-equity loans usually is fixed, based on prime rate, and is therefore higher than the 30-year fixed mortgage rate. Closing costs are significantly lower than for refinancing.

Tip: If you're borrowing to repay credit-card debt, lump-sum home-equity loans are probably best, since you can't go back to the equity well and push your debt up again, as you could with a credit line (below).

  • Home-Equity Line of Credit

Best for: Expenses that are spread out over time or inevitably run over budget, like a kitchen remodeling. With the revolving balance, you can tap into your home's equity as needed -- generally for up to 10 years. You can also keep the credit line as a kind of emergency fund, for events such as a job loss.

Costs: Rates are usually variable, based on the prime rate plus some margin, and many offer low teaser rates for the first six months. An annual fee of $30 to $75 usually kicks in after the first year. Closing costs, including an appraisal, can run from $350 to $500, but in the current competitive market, lenders often cover these costs.

Tip: Some lenders may offer a lower interest rate if you pay points up front. But it's not a good idea if you plan to use your line as an emergency cash-flow tool: You pay points on the entire line available, regardless of how much you actually tap.

-- Ms. Breckenridge is a staff reporter for SmartMoney.

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