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 refinancing may provide you with cash using your home’s 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.
Cash-Out Refinance Rates (December 2020)
Home Equity Loans vs. HELOC vs. Cash-out Refinancing
Lump sum payment
Home Equity Loan
Fixed or adjustable rates
Lump sum payment
Line of credit
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 to 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
What are Home Equity Loans and HELOCs?
HELOC, short for a home equity line of credit. A HELOC loan is basically the same thing as a home equity loan except instead of getting the money in a lump sum you will have a line of credit you can borrow from as needed.
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 credit line that you can borrow money out of whenever you need it. You are only charged interest on the amount you borrow.
Home Equity Loan Pros and Cons
Combined Loans to Value Ratio (CLTV)
The loan-to-value ratio or LTV ratio is the ratio of the property’s market value against the remaining mortgage balance.
For example, if you have a home worth $200,000 and the remaining loan balance on your mortgage is $100,000, you have a 50% LTV ratio. With a cash-out refinance, 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. are $2,000 per month, your DTI ratio is 40%.
You will need 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 cash-out refinance could be a great option for you.
However, some risks come along with using your home equity as collateral for a loan. If for any reason you’re unable to make the payments you could lose your home.
You must understand all the options available to you before taking any loan.