Refinance

The equity in your home can help you achieve a number of financial goals. Cash-out refinances and home equity loans are two ways you can get cash from your home to put towards different purposes. Learn the differences between a cash-out refinance and a home equity loan so you can decide which one is right for you.

What Is a Cash-out Refinance?

What Is a Cash-out Refinance?
What Is a Cash-out Refinance?

Most homeowners can do a cash-out refinance when the value of their home increases and they’ve accumulated equity. A cash-out refinance pays off your first mortgage and becomes your new mortgage, allowing you to take out some equity. If you think that your home value has gone up since you bought it, you might want to look into this option if you need cash for home renovations or something else.

How Does It Work? 

A cash-out refinance is when you replace your existing mortgage with a new one. After your loan money is disbursed, you get to keep the difference between your new loan amount and your current mortgage loan balance (minus the equity you’re leaving in your home and any closing costs and fees, of course).

Suppose your home is worth $200,000, and you have $100,000 left on your mortgage. You need to leave 20% of the home’s equity in order to take cash out. If you were to refinance your home with a new loan amount of $160,000, you would get $60,000 minus closing costs and fees.

How Much Equity Can You Take Out of Your Home?

You might be able to do a cash-out refinance, but you usually can’t borrow the entire value of the home. Some loans require that you leave some equity in the home, while others do not. Qualifying for a cash-out refinance requires that you have at least 20% of the equity in your home. But for VA loans, you can get a 100% loan-to-value mortgage.

Read More: How To Maximize Your Home Equity? Best Ways To Tap Into Your Home Equity.

Using Your Cash-out Refinance Funds

The cash you get from a cash-out refinance can be used in any way you like. Most people get a cash-out to refinance for home renovations, but the money is yours to use however you see fit.

What Is a Home Equity Loan?

What Is a Home Equity Loan?
What Is a Home Equity Loan?

A home equity loan is a second loan that is separate from your mortgage and allows you to borrow against the equity in your home. Unlike a cash-out refinance, a home equity loan does not replace your current mortgage. This is a second mortgage with separate payments. Home equity loans tend to have higher interest rates than first mortgage loans.

How Does It Work?

The loan term for your original mortgage will not change because your home equity loan is an entirely separate loan from your first mortgage. Once the home equity loan closes, you will receive a lump sum payment from your lender, which you will be expected to repay, usually at a fixed rate.

Certain Restrictions on Your Loan

You will not be allowed to borrow 100% of your equity from a lender for a home equity loan. Depending on the lender, the maximum amount that you can borrow is usually between 75% and 90% of the home’s value. As with a cash-out refi, the amount you can borrow will depend on factors like your credit score, debt-to-income ratio, and the loan-to-value ratio.

Similarities Between Home Equity Loans and Cash-out Refinances

  • You get your money right away: If you choose a cash-out to refinance or a home equity loan, you will receive a lump sum cash payment within three business days after closing. The waiting period is due to the fact that you have a right to change your mind about a refinance. It’s possible to spend the money on anything you need.
  • You borrow against your home’s equity: Both of these loans use your home as collateral, which means you can get lower interest rates for cash-out refinances and home equity loans than for other types of loans.
  • You can’t take 100% of your home’s equity: Most loan types require borrowers to leave some equity in the home.

Differences Between Home Equity Loans and Cash-out Refinance

  • Home equity loans are the second loan, while cash-out refinances are the first loan. You can use cash-out refinances to pay off your existing mortgage and get a new one. A home equity loan is different from a mortgage and it adds a second payment.
  • There are better interest rates for cash-out refinances. Cash-out refinances have lower interest rates because they are first loans and will be paid first in the case of a foreclosure, bankruptcy, or judgment.

When Does a Home Equity Loan Make Sense?

It might be a good idea to look at home equity loans if you’re going to be forced to pay a higher interest rate on your mortgage. The higher interest rate on the home equity loan may not be worth it in the long run. If you crunch the numbers, you can determine if a home equity loan is right for you. You might want to look into a home equity line of credit or cash-out refi to see if they make more sense for your situation.

When Does a Cash-out Refinance Make Sense?

If your home’s value has gone up or you have built up equity by making payments, a cash-out refinance might be in your best interest. Cash-out refinancing is a great way to go if you want to borrow money for home improvements, school tuition, debt consolidation, or other expenses. If you have big expenses and you need money, a cash-out refinance can be a great way to cover them while paying little in interest.

Read More: Is Now a Good Time to Refinance Your Mortgage?

FAQs 

FAQs of Home Equity loan
FAQs of Home Equity loan

Which Is Cheaper: Home Equity or Refinance?

Home equity lines of credit and loans typically come with lower closing costs than cash-out refinances. Sometimes, the lender will absorb these costs as well. If you’re only borrowing a small amount of money, a home equity loan may be your best choice, as interest rates on a home equity loan can be comparable to your current mortgage rate.

What Are the Alternatives to a HELOC or Cash-out Refinance?

If you only need a small amount of money for a small project or to pay off a small debt, then you may want to consider a small personal loan or a credit card with low-interest rates. Both options would allow you to avoid the closing costs associated with home equity loans and home equity lines of credit.

Are You Going To Lose Equity When You Refinance?

No, you will not lose equity when you refinance your home. The amount you have repaid towards your home loan and how the market affects your home’s value are some of the factors that will affect your home’s equity. It is possible to increase your home’s equity by pulling from your home’s equity to make improvements or renovations. If your home appraises for $200,000, you will still own a $200,000 home after you restructure your mortgage. Rather than losing the equity, it is just being converted into funds.

The Bottom Line

Homeowners who want to turn home equity into cash can benefit from cash-out refinancing and home equity loans. How much equity you have available, what you will use the money for, and how long you plan to stay in your home are some of the factors to consider when choosing a move.

Do you have any questions about cash-out refinance and home equity loans? Leave a comment below or contact us for a free consultation.

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