You’ve spent several years in your home and are interested in converting the built-up equity into cash. Or maybe your home value has rapidly increased due to market conditions, and you want to capitalize by converting the equity into cash.
Traditional banks, credit unions, and online lenders offer home equity loans, home equity lines of credit (HELOCs), and cash-out refinances to help you access the equity in your home.
These options allow homeowners to borrow against the equity they have built up in their property over time. They also afford them the flexibility to use the cash to meet financial goals or cover other expenses. It’s important to fully understand the terms, costs and tradeoffs of each option when deciding how best to withdraw equity from your home.
A HELOC may be best if you need flexibility, while a cash-out refinance can provide a lower interest rate for a larger sum you won’t have to pay back as quickly. A home equity loan could be ideal if you have a specific plan for the funds, along with a strong credit score and a sizable amount of equity. Ultimately, knowing your specific goals for the cash will help you best identify the most ideal way to pull equity from your home.
Ways to Tap Your Home’s Value
Here’s a breakdown of the most common ways to tap into your home’s value.
Home Equity Line of Credit (HELOC)
A HELOC is a variable-rate debt product you can use to borrow against any equity you’ve built up in your home. Most lenders extend HELOCs of up to 85 percent of your loan-to-value (LTV). To illustrate, if your home is worth $600,000 and you owe $475,000, you could qualify for up to $35,000 ($600,000 * .85 – $475,000).
You’ll also need to meet the lender’s qualification criteria. Most will have minimum thresholds for your credit score and debt-to-income (DTI) ratio, and you’ll likely need a steady, verifiable source of income.
If approved for a HELOC, you will get access to a pool of funds accessible for a set amount of time. This is called the draw period, and you’re free to withdraw as much as you need, up to the limit. During the draw period, you will also make interest-only payments on the amount you borrow.
When the draw period ends, your access to the line will end. You will also commence repayment on the outstanding balance. Payments are due each month for the duration of the repayment period and could fluctuate over time.
Cash-Out Refinance Mortgage
A cash-out refinance swaps out your current mortgage with a new one that includes your existing balance and the amount of equity you pull out. Here’s an example of how it works: Your home is worth $350,000, and you owe $250,000. The lender agrees to a cash-out refinance of 90 percent of your LTV, so you borrow up to $65,000 ($350,000 * .90 – $250,000). If the loan is approved, you will receive $65,000 at closing to use how you see fit.
You will now owe $315,000 (or the original balance plus the amount of equity you borrowed). So, your monthly mortgage payments could be higher, especially if your new rate is steeper than what you had with the prior home loan.
Home Equity Loan
Like a HELOC, a home equity loan allows you to unlock up to 85 percent of the equity in your home. It also acts as a second mortgage. But the interest rate is fixed, and you won’t have access to a pool of cash to withdraw from. Instead, you will receive the loan proceeds in a lump sum and make equal monthly installments (for principal and interest) over a set period as the interest rate is fixed.
Differences and Similarities
It’s essential to understand the similarities and differences between loan products that allow you to convert a portion of your home equity into cash.
Home Equity Loan and HELOC vs Cash Out Refi Mortgage
Home equity loans and HELOCs act as a second mortgage and don’t require you to refinance your home loan. By contrast, a cash-out refinance replaces your existing mortgage with a new one that includes the amount of equity you take out of your home.
Comparison: A Closer Look at HELOC vs Cash Out Refi
Here’s a deep dive into the most critical differences between these home equity products.
Interest Rates
When comparing a HELOC and a cash-out refinance, you’ll find that interest rates differ. HELOCs usually have adjustable rates, which means the interest rate will likely fluctuate over the loan term, depending on market conditions. On the other hand, cash-out refinances often have a fixed rate. So, it won’t change during the repayment period.
Flexibility & Terms
A HELOC offers more flexibility in terms of borrowing and repayment periods when compared to a cash-out refinance. With a HELOC, you can draw from the line of credit as needed, only paying interest on the amount you actually borrow. By contrast, a cash-out refinance provides a lump sum of funds, which may result in steeper borrowing costs and higher monthly payments as you’re forced to pay interest on the entire loan amount. A HELOC might be a better fit if you require continuous access to funds over time. However, if you need a larger sum of money upfront, a cash-out refinance can be more beneficial.
Credit Score Implications
Both HELOCs and cash-out refinances have an impact on your credit score. A HELOC may have a lesser impact as it’s a new line of credit, increasing your total available credit. However, since your credit utilization is essentially reduced when you take out a HELOC, your credit score will likely follow suit.
However, a cash-out refinance replaces your existing mortgage, potentially lowering your credit score since it consolidates your mortgage debt into a single loan. Before deciding which is best, assess your credit situation and the impact each option could have on your credit score.
Tax Implications
When it comes to tax implications, both HELOCs and cash-out refinances might allow you to deduct the interest paid on the loans under certain circumstances. You can only deduct interest paid if the proceeds from the loan are used to buy, build or substantially improve your primary or secondary residence. Be sure to consult a tax professional before making a decision based on potential tax benefits.
Make A Smart Decision: Factors to Evaluate
When you’re ready to move forward with a home equity loan product, keep these factors in mind as you evaluate your options.
Assessing the Equity in Your Home
Start by determining the equity in your home, which is the difference between its current market value and the remaining mortgage balance. Both a HELOC and a cash-out refinance allow you to access a percentage of this equity.
The more equity you have, the more funds you can withdraw from your home. To find out the current market value of your home, consider getting an appraisal or using online tools to estimate your home’s value.
Analyzing Your Financial Situation and Goals
Your financial situation and goals also play a significant role in deciding between a HELOC and a cash-out refinance. A cash-out refinance provides a lump sum upfront, which can be used to pay down high-interest credit card debt, renovate your home or invest in other projects.
However, a HELOC offers a revolving line of credit that functions like a credit card. If you need more flexibility or anticipate ongoing expenses, a HELOC may be more suitable for your specific needs.
Evaluating Current Market Conditions
Current market conditions impact the interest rates and terms of both financial products. With a cash-out refinance, you’ll generally receive a lower fixed interest rate for the entire loan term, which can be 15 or 30 years.
A HELOC usually has a variable interest rate, making it sensitive to market fluctuations. To make the most informed decision, compare the interest rates and costs of each option. Be sure to take into account your anticipated financial needs and their respective repayment terms.
Consulting with Financial Experts
It’s essential to consult with a financial expert before making a decision. A reputable financial advisor can offer valuable insights into your unique financial situation and help you make the most appropriate choice for your specific goals and needs.
They can also help you navigate the complexities of a HELOC or cash-out refinance and provide guidance on rates, terms and fees associated with each option. By seeking professional advice, you’ll be better prepared to make an informed decision that works for you.
The Right Choice for You: HELOC vs Cash Out Refi?
As mentioned above, it is essential to consider your financial needs and goals when deciding between a HELOC and cash-out refinancing. Both options allow you to access your home’s equity, but each has its own advantages and disadvantages.
Remember, a HELOC operates as a revolving line of credit, allowing you to borrow funds as needed, up to a specific limit. This option provides flexibility, as you only pay interest on the amount you actually borrow. However, the interest rates on HELOCs are usually variable, which can lead to unpredictable monthly payments. Also, remember that the repayment period for a HELOC typically kicks in after a “draw period” of 10 to 20 years.
On the other hand, cash-out refinancing involves swapping out your existing mortgage with a new one, often with a higher balance, as aforementioned. You’ll get the difference between the two in cash, which can be used however you see fit. This option allows you to potentially secure a lower interest rate, depending on market conditions. Cash-out refinancing generally has higher closing costs than a HELOC, as it involves a new mortgage. However, it offers the predictability of fixed monthly payments and a potentially lower interest rate.
Here’s a recap of some key points to consider when choosing between HELOC and cash-out refinancing:
- Closing costs: Cash-out refinancing typically involves higher closing costs. Ensure you have the funds available or are willing to roll the costs into the new loan.
- Loan term: Cash-out refinancing usually extends the repayment term of your mortgage, while HELOCs have a separate repayment period.
- Interest rates: Cash-out refinances may offer lower rates, while HELOCs usually have variable rates that can lead to fluctuating payments.
- Financial goals: Consider how you plan to use the funds and the timeline for repayment. Cash-out refinancing might be more suitable if you need a lump sum for a specific purpose. For ongoing expenses or projects, a HELOC could offer more flexibility.
The Bottom Line: How to Choose the Right Home Equity Product
Before selecting a home equity product, evaluate how you plan to use the funds to determine the best option.
HELOC: Best for homeowners who want access to a pool of cash to borrow against as needed.
A HELOC could be a viable option if you want a flexible loan solution that’s easy to manage. You’re not obligated to take the total amount and will only be responsible for any withdrawals you make.
Home Equity Loan: Best for homeowners with equity who want a lump sum of cash.
A home equity loan may be a better fit if you have a sound reason for wanting the cash and can comfortably afford to make the monthly loan payments. But if you fall behind on loan payments, the lender could foreclose your home to recoup their losses.
Cash-Out Refinance Mortgage: Best for homeowners who want to consolidate debt or fund expensive home renovations.
While a cash-out refinance likely means a higher monthly mortgage payment, you could free up funds to invest or meet other financial goals if the funds are used to pay off high-interest debt. And if you’re planning to make improvements to your home, your property value could increase substantially.
Ultimately, the choice between a HELOC and cash-out refinancing depends on your financial situation and priorities. Examine your needs and weigh the pros and cons of both options. Consult with a financial advisor or mortgage lender for guidance tailored to your unique situation.
