Dear Dr. Don,
My home is in need of a new roof as well as some other home improvement projects (finishing the basement and sunroom, etc). Should I refinance (my current loan is at 5.75 percent) and take out additional monies? Or is it better to take out a home equity loan (my bank is running a promo of 4 percent) to acquire the cash needed? My current loan is approximately $206,000 with an appraised value of $300,000-plus. Any assistance that can be provided would be helpful.
— Lee Leverage

Dear Lee,
There’s a lot to consider. Let’s start with the teaser rate on the home equity loan. You want to determine whether it’s a home equity line of credit that is an adjustable-rate loan, or a home equity loan with a fixed rate of interest. Odds are it’s a HELOC with a promotional rate that will be with you for a limited time only. As I write this, Bankrate’s national average for a HELOC is 5.72 percent, compared to 7.8 percent for a home equity loan.

The closing costs for a home equity product are often substantially less than those associated with a first mortgage, giving it an advantage over a cash-out refinancing. Nationwide, the average origination and title fees on a $200,000 mortgage in 2009 totaled $2,732, according to Bankrate’s annual survey of mortgage closing costs.

Put together a budget for your roof and other projects to estimate how much you’ll need to make the repairs and renovations. Once that’s done, estimate how long it would take you to pay off a loan for just that amount.

If you have the room in your household budget for this additional loan payment, the HELOC or home equity loan saves money by funding the projects over a shorter time span than a cash-out first mortgage.

However, the cash-out first mortgage refinancing may make sense if you can refinance at a lower interest rate. Bringing down the interest rate on the $206,000 loan balance, along with financing the repairs and renovations, gives you a better reason for paying the higher closing costs. The current Bankrate national average for a 30-year fixed-rate loan is 5.15 percent. Bankrate’s “Refinance interest savings calculator” will estimate the interest savings from refinancing.

If you plan on being in the house for a while, and you’re not just having the work done to get the house ready for resale, the cash-out refinancing might be a viable option. Just make sure you’re not borrowing so much that you have to pay private mortgage insurance on the loan. That would take place if the loan-to-value was over 80 percent of the home’s appraised value.

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