Cash Out Refinance vs Home Equity Loans


cash-out refinance vs HELOC

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)

Loan Term

Interest rate

APR

30-year fixed-rate

3.46%

3.62%

15-year fixed-rate

3.16%

3.39%

5/1 adjustable-rate

3.62%

3.94%

Home Equity Loans vs. HELOC vs. Cash-out Refinancing

Loan Type

Credit Score

Interest rate

Funds Dispersement

Cash-out Refinance

620

Fixed-rate rates

Lump sum payment

Home Equity Loan

660

Fixed or adjustable rates

Lump sum payment

HELOC

660

Variable rate

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

Pros

Cons

  • Low fixed interest rate

  • Pay offl high-interest debts

  • Payments are tax-deductible

  • Have a single mortgage payment

  • Closing costs are as much as a new mortgage

  • Reduces the amount of equity in your home

  • Home at risk of foreclosure if you can't make the monthly payments

  • May increase your mortgage payments

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.

See if You Qualify for a Home Equity Loan

Home Equity Loan Pros and Cons


Pros


Cons

  • Pay interest only on the amount borrowed

  • Low interest rates

  • Get cash to make renovations or repairs

  • Pay off and borrow at any time

  • No fees to take out cash

  • Increase the value of your property

  • Reduces your equity each time you use it

  • Has a variable rate

  • Could face foreclosure if you're unable to make payments

  • Closing costs between 2% - 5% of the credit line

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.

Debt-to-Income Ratio

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.

The Bottom Line

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.

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