Home equity loans and cash-out refinances are both similar financial tools used by homeowners who need a quick source of funding. If you’re considering borrowing against your home, you’ll want to understand the differences between a home equity loan vs. refinance cash-out.
Equity is the difference between what you owe on your mortgage and how much money you could get for your home if you sold it. This guide will help you understand the basics of both to help decide which is right for you!
HOW A HOME EQUITY LOAN WORKS
A home equity loan is a secured loan that allows you to borrow against your home’s equity. These loans offer a fixed interest rate and repayment term. The interest rate you’re approved for likely depends on your personal financial history, which includes factors such as your credit score, payment history, loan amount, and income.
Home equity loans usually offer lower interest rates than credit cards or other unsecured loans. Many lenders prefer that you borrow no more than 80 percent of the equity in your home.
If your credit improves after obtaining the loan, you might be able to refinance for a lower interest rate. Keep in mind, you’ll need a good amount of home equity to qualify — usually 15% to 20% or more. You’ll pay these funds back on a fixed schedule over the loan term. Your monthly payment will be based on the amount borrowed, term length, and interest rate.
Repayment and Costs
If you take out a fixed-rate home equity loan, your payments are predictable over time. From the start of the loan, you know exactly what your interest rate and payments will be for the entire duration of the loan. These don’t change during the payback period. This allows for the easiest budgeting to factor into your financial plan.
Keep in mind the costs related to taking out a home equity loan. You may be required to pay additional fees such as closing costs, title work, and a home appraisal. Also, since you’re using your home as collateral, lenders can foreclose on your property if you can’t make your payments.
HOW A CASH-OUT REFINANCE WORKS
A cash-out refinance happens when you refinance your current mortgage to a new mortgage — usually at a lower interest rate. In the process, you borrow more money than what’s needed to pay off your current mortgage. The first mortgage is then paid off in full and you get a lump-sum payout of the extra cash amount at closing.
There aren’t any restrictions on how the “cash-out” can be used, so it can be a great opportunity to pay down high-interest debt, make home improvements, or even put a down payment on an investment property or vacation home.
Costs and Fees
Closing costs with a cash-out refinance vary depending on where you live and your lender. To avoid any surprises, expect to pay between 2% – 5% of your loan on closing costs when you refinance. These costs are paid at closing and can include the mortgage origination fee, title search fee, attorney fees, points, prepaid interest, and other mortgage-related costs.
If you’re well-qualified, you could be offered a cash-out refinance loan without any closing costs. Keep in mind this usually means you’ll have a higher interest rate. While this will decrease your upfront costs, the tradeoff may be a higher monthly payment or paying more interest over the life of the loan.
Repaying a cash-out loan requires a single monthly payment. Cash-out refinance rates are usually slightly higher than a traditional refinance rate. Your rate may depend on how much cash you want to take out plus your credit score. Typically, rates can be anywhere from 0.125% to 0.5% higher than rates you find for a no-cash-out refinance mortgage.
Cash-out refinancing means you are borrowing money against the equity in your home and the home will be used as collateral. If the loan is not paid back in on-time monthly payments, the lender can put a lien on the property and foreclose.
CHOOSING A HOME EQUITY LOAN VS. REFINANCE CASH-OUT
When you’re considering a home equity loan or refinance cash-out, the best option depends on your personal finances. You’ll want to know what your current mortgage rate is, the amount of equity you have in your home, and for what purpose you need the money.
If you have a high mortgage interest rate or an adjustable-rate mortgage that’s about to increase to a higher rate, then a refinance cash-out is the better option. This enables you to refinance to a lower rate and get cash out at the same time.
However, if you have a low interest rate (under 4%) then you may not want to risk losing your low rate in a refinance. If this is the case, consider going for a home equity loan.
While both of these types of loans are secured by the equity in your home, they don’t require a mortgage refinance. Use our calculator to compare both options specific to your current financial situation.
ELEVATE YOUR HOME’S EQUITY AT FIBRE FEDERAL
Whether you choose a home equity loan or cash-out refinance, be sure to consider why you need the cash, when you need it (now or later), and how long you plan on staying in your home.
With Fibre Federal Credit Union, we ensure you get all the money you need, right when you need it, with our home equity loans.
Click below to learn more about our loan options and apply today!
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