A home is a great investment because you build equity with every payment you make.
If you have some equity built up in your home you may be able to get a loan using your equity as collateral.
There are two ways you can do this, either by getting a home equity loan, or HELOC, or with a cash-out refinance.
HELOC and cash out refinances may both provide you with cash using your homes equity, they are very different.
In this article we’re going to dive into the differences so you can compare a cash-out refinance vs HELOC to see which refinance option is best for you.
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What is a Cash Out Refinance?
Cash-out refinancing is when you take your existing mortgage loan and replace it with a new loan for more than your loan balance. Whatever extra you borrow you will receive as cash and just one loan payment is needed.
With a cash-out refinance you can usually borrow up to 80% of the value of your home. You will need at least a 30% equity stake to qualify.
For example: Your home is worth $200,000 and your mortgage balance is $100,000. You can get a cash-out refinance for up to 80% of the LTV ratio, meaning you can borrow up to $60,000.
There are cash-out refinancing options for conventional loans as well as FHA loans.
Cash-out Refinance Pros and Cons
- Lower interest rate than personal loans
- Use cash to pay off other high interest debt
- Eliminate credit card debt
- Make renovations and repairs to your home that increase it’s value
- Interest payments may be tax deductible
- Use the extra cash however you want
- A single payment for the cash and mortgage
- Get a lower interest rate on your mortgage
- High closing costs (2-4%)
- Reduces your equity in your home
- If you cannot make the payments you could face foreclosure
- Could land you in more debt if you do not spend money wisely
What is a HELOC?
HELOC stands for home equity line of credit. A HELOC loan is basically the same thing as a home equity loan. Using the equity in your home as collateral you’re able to get a second mortgage loan. A HELOC is a separate loan on your home and you will have a second payment to make each month.
A HELOC works similarly to a credit card. You will have a revolving line of credit that you can borrow money out of whenever you need it. You are only charged interest on the amount you borrow.
Pros and Cons of HELOC Loans
- Access the equity in your home
- Lower interest rate than other types of loans
- get cash to pay off high interest debt
- Make renovations or repairs to your home
- Increase the value of your property
- Lose equity in your home
- If you’re unable to make the payment you could lose your home
Combined Loans to Value Ratio (CLTV)
The loan-to-value ratio, or LTV ratio is the ratio of the market value of the property against the remaining mortgage balance.
For example if you have a home that is worth $200,000 and the remaining loan balance on your mortgage is $100,000, then you have a 50% LTV ratio. With a cash out refi, home equity loan or line of credit you are able to have a combined loan-to-value ratio of up t0 80%.
If you owe $100,000 on a $200,000 home, you will be able to borrow up to $60,000, or 80% CLTV.
Your debt-to-income ratio (DTI) is the amount of monthly debt obligations you have compared to your monthly income.
For example is you make $5,000 per month before taxes and your total monthly debt payments such as credit cards, loan payments, mortgage, etc. is $2,000 per month, your DTI ratio is 40%.
You will need to be able to meet the DTI requirements to qualify for a home equity loan or cash out refinance.
If you need some extra cash to make repairs or renovations to your home then a home equity loan or cash0out refinance could be a great option for you. However, there are some risks that come along with using your home equity as collateral for a loan.
It’s important that you understand all the options available to you before you take out any type of loan. Speak to an experienced loan officer to cover all of your options.