When you pay off your home mortgage, you’re actually building something called home equity in the process. Home equity relates to the amount of money you’ve put into your home, and some lenders will let you borrow against that equity when you need money for renovations, investments, and more.
You have many options for capitalizing on your home equity—including through ways like cash-out refinancing and home equity lines of credit (HELOC).
Smart homeowners will compare the advantages and disadvantages of a cash-out refinance vs. HELOC. Here, we’ll discuss each home equity loan type and when homeowners may want to choose one over the other.
Cash-Out Refinance vs. HELOC: A Quick Comparison
Figuring out whether a cash-out refinance or a home equity line of credit is better for your situation depends on several key factors. Before deciding, you’ll need to determine the following:
- Your current interest rate for your mortgage
- The amount you intend to borrow
- When you’ll pay back the money
- Your current equity
- Whether your term is fixed or flexible
Both means of financing are suitable for different things. HELOCs tend to be best for home improvements that add to your home’s value. Cash-out refinance is similar to taking out the first mortgage and popular for debt consolidation.
We’ve just skimmed the surface of these loan types and what they offer, so now let’s get into the details.
Home Equity Lines of Credit (HELOC)
A home equity line of credit, commonly known as HELOC, is a line of credit secured by your home. The majority of HELOCs contain adjustable-rate, interest-only payments for a set amount of time.
A unique aspect of HELOCs is their “draw” period, a 10-year time span in which a person can access their funds. Once this period ends, you must repay the withdrawn balance over a 15- or 20-year term, depending on the lender.
A HELOC is generally best for those working on home projects, such as building an extension or gutting out the inside for upgrades.
Borrowers with a suitable income who earn more than they owe (debt wise) typically qualify for a HELOC. This kind of financing ranges between 80-90% combined loan to value.
HELOC Pros and Cons
The best part about a HELOC is that a homeowner can borrow a small amount for a short period. You may qualify for more, but you’ll only need to repay what you withdraw.
For example, suppose you only need $15,000 for your project. You plan to repay that between three and five years.
However, on the downside, having access to a large sum of money may make homeowners tempted to tap into what they don’t need. Always have your long-term goals and project plans set out before dipping into your HELOC.
A Fixed-Rate HELOC?
Some financial institutions offer fixed-rate conversions for their HELOCs. Homeowners can convert a portion or even all of their HELOC into a fixed-rate loan. Occasionally, lenders may charge a fee for conversion.
This option is excellent for those who are looking to take advantage of low-interest rates. You may be able to take out up to three fixed-rate HELOCs at once.
Cash-out mortgage refinancing is a new mortgage that gives homeowners cashback when the loan closes. It’s excellent for those wanting to refinance their home and take cash out at the same time.
Eligibility is similar to that of your first mortgage, but you’ll need to have a more considerable equity status on your home. You’ll most likely need a credit score of at least 620.
Lenders generally limit this refinancing option to 80% of the home’s value. As with any loan, borrowers should have a direct reason. Never take cash just because you can.
Pros and Cons of Cash-Out Mortgage Refinancing
Homeowners can expect a sizable loan, depending on their home’s equity. Plus, cash-out refinancing comes with relatively low-interest rates because it’s your home that secures the loan.
Since you’ll start from square one on your housing debt, your overall interest cost will increase. There’s also the disadvantage of high closing costs and fees, but this will vary from lender to lender.
Cash-Out Refinance vs. HELOC: Loan Similarities
As with most loans, your credit and finances will need to be in decent standing to gain approval.
You can use the money as you’d like, but financial advisors recommend only borrowing for improvements that add value to the home or for debt consolidation.
Keep in mind that your home is collateral. Failing to make payments may lead to foreclosure. Only consider taking out these loans if you feel confident you can repay them.
What To Consider Before Choosing Your Loan Type
When comparing cash-out refinance vs. HELOC, it all boils down to your personal needs and finances. Here are significant considerations to consider:
- Interest rates and closing costs. When shopping around for lenders, note their interest rates and closing costs. HELOCs may have higher interest rates, while a cash-out refinance may have higher closing costs.
- Your current interest. If you’re not careful, you may end up with a higher rate on your loan. But you could end up with lower. It all depends on your repayment terms, loan balances, and interest rates. Be sure to examine your options thoroughly.
- Pay attention to the market. Financial crises are very likely to hit home equity products hard. Lenders will try to protect their assets with strict eligibility requirements and lower loan amounts. Lending agencies may not even offer options like the HELOC at all. If you’re considering either of these loan options, keep your eye on the market and how banks respond.
Still Deciding? We’re Here To Help
Choosing a loan type is a significant decision and can be overwhelming. You want to be sure you’re making the most financially sound choice. Don’t worry if you’re still not sure which path to choose!
The good news is that our team here at Associates Home Loan is eager to help. Whether you’re considering cash-out refinance vs. HELOC, we’ll guide you through the process every step of the way. We’ll answer any questions you may have and ensure you find the loan that meets all your needs.
Contact us today to discuss your options and get help finding what’s best for you.