Paying off credit cards, starting a new business and tackling home renovations – these are just some of the many reasons that homeowners could use extra money that they don’t have. For many homeowners, they have an unrealized resource for these kinds of situations — the ability to tap into their equity. There are a few common ways of doing this: through cash-out refinances, home equity loans and home equity lines of credit. But what are they, and how do they differ from one another?
A cash-out refinance replaces the mortgage you’ve already taken out with a higher one. You get to keep the difference between the old and new mortgages, which is given to you in the form of a check. In other words, this type of refinancing lets you “cash out.”
Let’s say you currently have a $100,000 mortgage on a $200,000 house. You also have $20,000 in debt that you’d like to pay off – a $10,000 car loan, $5,000 in credit card debt and another $5,000 in student loans. By refinancing and getting a new mortgage for $125,000, you would pay off the original $100,000 mortgage and you’d get to keep $25,000. With that $25,000, you could pay off your car loan, credit card and student loans, and you’d have an extra $5,000 to put toward renovations, save or spend how you choose.
With today’s low interest rates, in most cases, it will cost you less money to take out an additional $25,000 in your mortgage than to pay the interest on your current $20,000 debt.
Home Equity Loans and HELOCs
A home equity loan is another loan you pay in addition to your current mortgage. With these kind of loans, your home’s equity is used as collateral and you’re given a lump sum of cash on which you make payments. These loans are commonly referred to as “second mortgages,” and the interest rates are usually lower than interest on credit cards, but still higher than a cash-out refinance. One of the biggest drawbacks is that unlike a cash-out refinance, you’re essentially paying two mortgages at once, which can create some extra financial strain.
A home equity line of credit, or HELOC, is similar to a home equity loan, but instead of receiving a lump sum of cash, you’re given a line of credit that you can use when you’d like. Think of it like a credit card, but with a lot more to lose – you make monthly payments for what you spend, but if you miss a payment with a HELOC, your house is on the line. A lot of times, HELOCs also come with adjustable interest rates, which aren’t always as attractive as fixed-rate loans. There also tend to be more fees associated with HELOCs than with home equity loans, and lenders will usually cap financing at less than 100%.
Home equity loans and HELOCs may have some perks, but they’re not nearly as common these days as cash-out refinancing, which arguably touts many more benefits that can help out homeowners in the long run.
Cash-out Refinancing Benefits
Consolidate debt – If you followed through with the above example, you would be consolidating your debt so that you would no longer have to worry about making your monthly car loan, credit card and student loan payments or paying late fees on any of them.
Lower interest rates – Because mortgage rates are so low right now, using a cash-out refinance to consolidate your debt means you could pay just one low, overall interest rate. For example, if your credit card carries a 15% interest rate and you pay it off with a cash-out refinance, you’d only be paying the interest on your mortgage. Even if you think your current interest rate on your mortgage is pretty good, you could be eligible for a mortgage with an even lower rate. In fact, by refinancing, you could be saving $100 to $200 each month.
Shorter term – With a cash-out refinance, you could potentially shorten your mortgage and pay it off sooner. Paying off your mortgage earlier than planned means more money in your pocket and extra flexibility.
Increase your home’s value – Keep in mind that if you use a cash-out refinance to pay for home renovations, they can sometimes add value to your home. For instance, if you remodel your kitchen or insulate your attic, in the long run, these projects may help you recoup some of the money you cashed out.
If you’re considering a cash-out refinance, you should act now while rates are low, especially as rates are projected to increase this year. At PrimeLending, we’re here to help make refinancing simple for you. We have 30 years of experience of walking homeowners through refinancing. Contact a PrimeLending loan specialist to answer your questions, assess your individual options and get started today.
From the PrimeLending blog, by Mandy Jordan