Are you looking to access the equity you’ve built up in your home? Whether you purchased the property some time ago or benefited from increased home values, there are home equity products you can use to borrow against your equity.
Two popular options are home equity loans and cash-out refinances. Keep reading to learn how they work, the key benefits each offers and how to choose the right fit for your financial situation.
Home Loans and Mortgage Refinancing
What is a Home Equity Loan?
A home equity loan is a fixed-rate additional mortgage that lets you convert between 75 and 80 percent of the equity you’ve built up into cash. You’ll receive the loan proceeds in a lump sum and make equal monthly installment payments over a set period, generally between five and 30 years.
To illustrate, assume your home is worth $425,000 and you owe $250,000 on the mortgage. You may be able to get a home equity loan of up to $90,000 ($425,000 * .80 – $250,000).
Pros of a Home Equity Loan
Lower, Fixed Interest Rates than Your Existing Mortgage
If your credit score has improved or market conditions have changed, you could get a much lower interest rate and pay less over the loan term.
Lower Monthly Payments
A lower interest rate also means your monthly payment will decrease, and it won’t fluctuate since it’s fixed.
Easier to Qualify for a Lump Sum if You Have Enough Equity
Home equity loans are relatively easy to qualify for if you have good or excellent credit and a substantial amount of equity built up in your home.
Possible Tax-deductible Interest
You could qualify for a tax deduction on interest paid if the funds are used to improve your home.
Lenders May Waive or Reduce Closing Costs
Some lenders agree to waive closing costs on home equity loans to sweeten the deal.
What is a Cash-out Refinance?
A cash-out refinance is a mortgage product you can also use to pull equity out of your home. But it doesn’t act as a second mortgage. Instead, it swaps out your current mortgage with a new one with different terms.
You can generally borrow up to 85 % of your home equity. Using the example above, you’d be able to pull up to $111,250 ($425,000 * .80 – $250,000) out of your home. Upon approval, the new lender would pay off your existing mortgage and disburse $111,250 to you within a few business days following closing. You’d then commence repayment with the new lender on the new mortgage loan of $361,250 ($250,000 + $111,250).
Pros of Cash-out Refinancing
Lower Your Rate and Payment
With a cash-out refinance, you can also lower your interest rate and monthly payment if your credit health or market conditions have changed since you took out your current mortgage.
Convert Your Adjustable Rate into a Fixed Rate
If you’re tired of fluctuating monthly payments, you can use a cash-out refinance to switch from an adjustable-rate mortgage to a fixed-rate mortgage.
Home Loans and Mortgage Refinancing
Shorten Your Term-loan
You may be able to switch from a 30 to a 20- or 15-year fixed-rate mortgage product.
Take Cash out to Consolidate Your Debt
Instead of spending a fortune to pay off high-interest debts, you can use the cash you pull out to pay off your balances.
Take Cash out for Home Improvements
You can stop putting much-needed home repairs and upgrades on hold and pull cash out to cover the costs. As a result, the home will be more appealing to you, and the property value could increase.
Take Cash out to Purchase Investment Property
If you’re purchasing a second home and converting it to a rental, the funds from a cash-out refinance can be used for the down payment or pay cash for the property.
Remove Private Mortgage Insurance
You may be eligible to remove private mortgage insurance if the loan-to-value (LTV) on your new loan is below 80 %.
Cash-out Refinance vs. Home Equity Loan: Overview
While there may be similarities between the two home equity products, you can borrow against your home’s equity, and you’re free to use the funds however you see fit. But they have a few key differences and some factors worth considering when choosing between the two.
Things to Consider When Choosing between a Cash-out Refinance vs. Home Equity Loan
Current Mortgage Rates
Did interest rates drop since you took out your mortgage? If your credit score is good enough to qualify you for a lower interest rate and you plan to stay in the home for some time, a cash-out refinance could be more viable.
How Much You Want to Borrow
Home equity loans are more ideal if you only want to borrow a small amount as you’ll avoid steep closing costs. But if you do a cash-out refinance, you’ll pay far more at the closing table to swap out your current loan for a new one.
Your Plans for the Money
You may want to steer clear of a home equity loan and cash-out refinance if you’re unsure how to use the funds. Instead, a home equity line of credit (HELOC) could be more suitable as you’ll have the flexibility to borrow on an as-needed basis and only pay interest on the amount you borrow.
How Long You’ll Live in the Home
If you’re planning to stay put for some time, a cash-out refinance could be better. But if you’re selling within the next few years, a home equity loan will likely save you more money since you’ll steer clear of closing costs.
When to opt for a Home Equity Loan
A home equity loan is perfect if you have a good or excellent credit score. You can qualify for a lower interest rate than you currently have and if you don’t mind making an extra monthly payment. The lender should also waive closing costs to make the deal more appealing.
When to Opt for a Cash-out Refinance
A cash-out refinance could be ideal if you want a single mortgage product, as it’s much easier to manage. It’s also a better fit if you have less than perfect credit since you’ll have a greater chance of getting approved.
If you’re ready to refinance your home to lower your payments or convert your equity to cash, consider loanDepot to help you get started. loanDepot is a direct lender with over a decade in the industry, and it’s funded more than $179 billion in mortgage refinances to date.
There are over 200 locations nationwide to serve you. Simply submit your details to learn more about refinancing options that could be a good fit for you.