Is it time for you to choose between a cash-out refinance or a home equity loan? Though both require taking out money based on the collateral of your home, they have particular advantages that could benefit your financial health and the value of your home in the long term.
Understanding Home Equity
Home equity equals the total value of your home that has been paid off. And though your home still belongs to your lender until your home is sold or you’ve paid it off completely, the equity is the amount of money you no longer owe on the home. Unless the home decreases significantly in value, the majority of your home equity is yours for the taking.
Refinancing Explained
Deciding if and when to refinance a home comes down to two main factors. First, if your household income has increased significantly or there is another reason you’re able to pay off your home in 15 years instead of 30, refinancing is a smart move. This will keep thousands of dollars in your pocket that could be lost on the interest rates paid over the additional 15 years, if the home had not been refinanced.
Additionally, if your household income has decreased or a financial crisis has impacted the speed at which a mortgage can be paid off, a mortgage can be refinanced to be paid off in 30 years instead of 15, for example.
Refinancing can be favorable for getting a new mortgage at a lower total interest rate. If the market has changed and you’re able to refinance at a lower interest rate, it will be worth the savings you’ll receive in the long run-even after paying the closing fees for the new mortgage-in most cases.
Cash-Out Refinancing
If you’ve decided it’s the ideal time to refinance your home, it’s time to shop around for a new mortgage with a lower interest rate and possibly a longer or shorter payback term. After this is done, the next step is deciding how much cash you’d like to take out from your home equity. Normally, lenders allow homeowners to take out 70%-80% of their home equity in cash during a cash-out refinancing. Though this money essentially is still owned by the bank, it is now yours in the form of a loan.
Home Equity Loans
As you might have guessed, a home equity loan is a loan taken out from the value of the home equity. Essentially, a homeowner is borrowing the money that has been paid off for their home. In most cases, the money is spent toward home renovations that return an increased value to the home. It is recommended that the money is spent paying off high-interest loans or other investments that pay you back in the long term.
Similarities between Cash-Out Refinancing and Home Equity Loans
The two are similar in that they both use the property as collateral. It is important to note that this can put the homeowner at risk of foreclosure if the home equity loan or the cash-out is spent flippantly. In both cases, the homeowner can normally borrow around 70%-80% of their home equity. The loan terms for these options are usually 30 years but always vary slightly from bank to bank.
The Core Differences
An equity loan is a second mortgage against a home with its own terms and interest rates. By contrast, a cash-out refinance entails getting a completely new mortgage for your home. Cash-out refinances commonly have closing costs because of this process. Additionally, the credit score requirements are usually lower on a cash-out refinance when compared to a home equity loan. This is due to the fact that one bank is the lender for the entire home with a cash-out refinance. Therefore, there is more financial gain and more security for the bank if the home is foreclosed. This is not the case with home equity loans as they require a separate loan from the original mortgage and give the bank less certainty that they will receive a high return on their investment if the home is foreclosed.
Closing Thoughts
Before choosing between the two options, take the time to shop around and learn where you can receive the best interest rates, refinancing options, or what investments are worth taking out a home equity loan or choosing a cash-out refinance. With these insights in mind, you’ll be sure to make an informed decision that your future will thank you for.
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