Cash-Out Refinance vs Home Equity Line of Credit (HELOC)
In many cases, accessing home equity offers an option for accomplishing more of your financial goals. There are options for tapping into your home's equity, like a cash-out refinance or a Home Equity Line of Credit to help you do so, and there are some differences between the two you should know.
Cash-Out Refinance Overview
A Cash-Out refinance is a way of tapping into the equity you have built up in your home as it has increased in value over time, and through your monthly payments. It involves retiring your current mortgage by taking out a new one, possibly with different terms, and for an amount that is larger than what you currently owe.
The excess funds left over after paying off your old loan’s outstanding balance and closing costs is then paid out to you in cash at closing.
Using a Home Equity Line of Credit (HELOC) gives a borrower access to a line of credit based on the available equity in a home and functions somewhat like a revolving credit card. It requires a 2nd monthly payment and features an adjustable interest rate. That means if interest rates go up, your monthly payment could also increase.
A Cash-Out refinance can have a fixed interest rate, so you could have a fixed mortgage payment for the life of the loan. With a HELOC, you have a line of credit with the ability to make withdrawals and a fluctuating interest rate. Your HELOC payment depends on how much you borrowed and the interest rate at the time you make your HELOC payments.
Cash-Out Refinance Benefits
Why Cash-Out refinance?
Cash-Out refinancing is usually more attractive to those home owners who have too much of their wealth tied up in their home and don’t have the cash assets on hand they would like. Home owners also tend to consider cash-out refinancing when interest rates are low.
If you've been thinking about getting a Home Equity Line of Credit, consider a Cash-Out refinance to access your home equity. You may want to use some of the money invested in your home to eliminate other debts, like credit card balances or to contribute to your children’s college tuition bills. Perhaps you’re looking to self-finance home improvement expenses or pay medical bills. You may even prefer to use it to fund vacation homes, a rental property, or start a business.
It should be noted that there is a big difference between using money from cash-out refinancing to pay for home renovations or debt consolidation, which are more of an investment in your home and can potentially increase the value, versus using the funds to buy a new car which has no return on your money.
A Cash-Out refinance could help you:
- Access a large lump sum of cash
- Pay off high interest credit card debt
- Pay off a car loan
- Pay student loans
- Pay off medical bills
- Finance a wedding
- Take a vacation
- Make home improvements
- Pay for elderly care
- Buy an investment property
- Pay for college
- Pay down debt and improve your debt-to-income ratio
- Boost your credit score
- Get a lower interest rate
- Improve your financial situation
- Get potential tax deductions (be sure to consult a tax professional)
- Have simple interest instead of compound credit card interest
Cash-Out Refinance Requirements
What is needed for a Cash-Out refinance?
In general, you'll need to meet minimum FICO requirements for the new loan and you'll need to have enough equity in your home for the refinance. An appraisal of your home may also be required.
If your home is worth $250,000 and you owe $150,000, then you have $100,000 in equity built up in your home. You could tap into that equity to cover any expenses you want. For example, if you owe $80,000 in credit card debt at a 15% APR, you could pull out $80,000 from your home’s equity and pay off higher-interest debt.
Be aware that normally you will not be able to take out 100% of your home’s equity; instead, you will be limited to between 80-90%.
Cash-Out Refinance Loan Options
What loan types are eligible for Cash-Out refinance?
The FHA 203k renovation loan, or Home Improvement loan, is designed for borrowers who are interested in financing home improvement, and it can be used to buy a house or to refinance. A Home Improvement loan is a type of Cash-Out refinance that allows you to use your home's equity to finance improvements or modifications to your home like:
- Removal of lead-based paint
- Decks, patios, porches
- HVAC systems (heading and air conditioning)
- Basement completion
- Basement waterproofing
- Updates to a septic or well system
- New kitchen appliances
- Washer and dryer upgrades
- Roofs, gutters, and downspouts
- Plumbing and electrical upgrades
- Minor kitchen or bathroom remodeling
- Installing carpet, tile, or wood flooring
- Restoring windows or doors
- Weather stripping and insulation upgrades
- Disability improvements
- Energy efficient upgrades
- New siding
- Building a home addition
Special Benefit for Veterans
Cash-Out refinancing can be especially attractive to homeowners who qualify for VA-backed loans. The VA will guarantee these loans up to 100 percent of the home’s value. With the VA standing behind the loan, the lender can typically offer more favorable terms. This type of loan can also be used to refinance a non-VA loan into a VA loan. Another benefit: VA loans are not subject to down payment limits or private mortgage insurance (PMI). You can check to see if you qualify for a Certificate of Eligibility here.
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