Can You Refinance a Home That is Paid in Full?

( – Though technically speaking, a homeowner cannot refinance a home that is paid in full, because there is no finance to re-. But homeowners certainly can access the equity in their paid-for homes to get some quick cash flow, which in essence becomes a refinancing.

In these cases, homeowners are putting their homes up as collateral for another type of loan, which also means they could face foreclosure on their homes if they fail to repay the loans.

Drawing a loan against a paid-for home generally falls under one of three loan types, which come with various advantages and disadvantages. A homeowner should decide which type of loan best fits their immediate need, or if they should consider another type of loan that doesn’t present a risk of losing their home.

These are the three types of loans homeowners can use along with some advantages and disadvantages.

Home Equity Loan

A home equity loan provides a homeowner with a large chunk of money quickly, based on the value of the home and the homeowner’s ability to repay the loan. Financial institutions that provide loans often place restrictions on how the money is used, such as for consolidating debt or to make improvements to the home.

Lenders generally limit the amount of the loan to 80 percent of the value of the home or require a mortgage insurance policy if you need more than 80 percent. Some lending institutions also place a cap on home equity loans, no matter the value of the home. For instance, the lender might have a $250,000 cap on home equity loans, so even if the home is valued at $500,000, the maximum the homeowner can borrow is $250,000.

The advantage of a home equity loan is that the interest rate will be considerably lower than other types of personal loans. Interest rates are lower because the financial institution takes less risk as they have the home as collateral if the lender fails to pay back the loan. They will come with closing fees, which range from 2 percent to 5 percent of the loan total, so that eats into those interest rate savings a bit. The homeowner also will have a fixed payment, so it’s easy to calculate how the payment fits into their budget.

The disadvantages are the homeowner will be limited in how they can spend the money and will be putting their home at risk.

Home Equity Line of Credit

The home equity line of credit (HELOC) will be similar to the home equity loan, but the homeowner will take the money out only as they need it, rather than in one lump sum. This saves on interest as the homeowner takes out the money only as they need it and only as much as they need at certain times. Payments then will be determined by how much is taken out and what the timeframe is for repayment, as agreed to between the lender and the homeowner.

The HELOC does not have as many restrictions on how the homeowner can use the money, though it certainly would be good for a long-term remodeling plan, where say the homeowner wants to remodel the kitchen one year, the master bedroom and bath the next year, and create an outdoor entertainment area in the third or fourth year.

But let’s say the homeowner wants to start a business and knows they need to buy equipment to start and maybe inventory at a couple of different times in the year, a HELOC might be a good way to start until the business can establish its own line of credit.

HELOCs also generally have a minimum timeline, such as five years, where the homeowner must actively be using the credit. The lender wants to ensure they are getting some return for their efforts to create and manage the HELOC.

Cash-out Refinancing

The least restrictive option is cash-out refinancing where the homeowner basically creates a new mortgage on their home to access their equity. Cash-out refinancing is similar to a home equity loan in that the homeowner must pay some closing costs and the loan is limited to 80 percent of the value of the home.

The lender might require mortgage insurance at a lower percentage of the value of the home because they have no control over how the money is spent.

Cash-out refinancing does still have the advantage of offering lower interest rates than other types of loans, and sometimes even lower than home equity loans.

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