When it comes to tapping into your home equity, there are a few choices that homeowners need to know. Two of the most important ones are HELOC and cash out refinance.
While they both serve similar purposes, they are actually quite different. In order to understand them better, let’s take a closer look at each one.
What is a cash out refinance?
A cash out refinance is a mortgage refinancing option where the new mortgage is for a larger amount than the existing loan in order to convert home equity into cash.
For example, if you owe $100,000 on your current mortgage and you refinance for a $200,000 cash out loan, you will receive $100,000 cash at closing.
The extra cash can be used towards renovation projects, consolidate debt, or any other purpose. The main difference between a cash out refinance and a home equity loan is that cash out refinances replace your entire mortgage while home equity loans are in addition to your existing mortgage.
Because cash out refinances essentially involve taking out a new mortgage, they come with all the same fees and closing costs as your original home loan. This includes origination fees, appraisal fees, and potentially even points if you choose to buy them down. As such, it’s important to calculate whether the cash you’ll receive from a cash out refinance justifies the costs associated with taking out a new mortgage.
In general, cash out refinances are best for those who have built up significant equity in their home and who want to use that equity for a specific purpose such as funding home improvements or consolidating debt.
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What is a Home Equity Line of Credit (HELOC)?
A home equity line of credit, or HELOC, is a type of loan that allows homeowners to borrow against the equity in their home.
Unlike a traditional home equity loan, which provides a lump sum of cash upfront, a HELOC offers borrowers the flexibility to withdraw funds as needed, up to the maximum line amount. The interest rate on a HELOC is typically lower than the interest rate on a credit card or personal loans, making it an attractive option for debt consolidation or major expenses.
Homeowners typically have 10 years to draw on the HELOC, with 20 year repayment period after which the line must be paid in full. HELOCs are secured by your home, which means that they are liens on your home. If you default on a HELOC, you will face the risk of foreclosure. For this reason, it’s important to consider all the pros and cons of taking out a HELOCs before making any decisions.
Now that you know the main differences between HELOCs and cash out refinances, let’s talk about when each one might be the right choice.
When to choose a cash out refinance
If you’re looking for a way to access your home equity without adding any more debt, a cash out refinance might be the right choice for you.
With this type of loan, you’ll be able to replace your existing mortgage with a new one for a larger amount. The difference between the two loans will be given to you in cash, which you can use for any purpose.
Another benefit is that if you have a higher interest rate on your mortgage than what is available in the present market, a cash out refinance will help you take advantage of the lower rates available.
Additionally, if you are paying PMI on your current loan, you may be able to cancel it with a cash out refinance. This will depend on the type of loan you have and other factors, so be sure to speak with your lender about this possibility.
Through a cash out refinance, you can also take a new loan with a lower term, so for instance, you could refinance a 30-year mortgage into a 15-year one. This may increase your monthly payments but you’ll end up paying less in interest over the life of the loan.
When to choose a HELOC?
A HELOC can be a good choice if you need to borrow money for a specific purpose and you want the flexibility to repay the loan over time.
For example, a HELOC could be a good way to finance a major home renovation project or consolidate high-interest debt or invest in buying another property.
Another benefit of HELOCs is that you can typically only borrow what you need, when you need it. This can help to keep your monthly payments down since you’re only paying interest on the amount of money you’ve actually borrowed. If you don’t owe anything on the HELOC, then you don’t have an interest charge or a monthly payment due.
What are some drawbacks of a cash out refinance?
What are some drawbacks of a cash out refinance
Although there are many advantages of a cash out refinance, there are some drawbacks to
that you should be aware of before taking out a new loan.
First, the closing costs of a cash out refinance can be expensive. Essentially, you are taking a new loan and the costs will be similar to when you bought the house. You need to be aware of your mortgage lender’s fees as well as third party fees and required government fees as well.
Additionally, cash out refinancing can lengthen the term of your loan, which means you’ll end up paying more interest over the life of the loan. However, you do have the option of taking a term that aligns with the amount of years that you owe or a lower term.
Finally, you start paying interest on the money that you borrow from day one. Remember that a cash out refinance gives you a lump sum of money at closing through the new loam amount and interest starts to count right away.
What are some drawbacks of a HELOC
One downside of HELOCs is that they typically have variable interest rates, which means that your monthly payments could increase if interest rates go up. In addition, they carry much higher interest rates compared to cash out refinances.
Another downside is that you will have two mortgage payments if you currently have a mortgage on your house. This can make budgeting a little bit more difficult. Third, if you don’t make timely payments on your HELOC, you could risk losing your home to foreclosure as this is a lien on your house as well.
Which is the best option for you?
When it comes to choosing between a cash out refinance and HELOC, there are several things you need to consider. The first is why you need the money. If you have a specific purpose in mind for the loan but you want flexibility, then a HELOC might be a better choice because you can borrow only what you need, when you need it.
However, if you’re looking for more flexibility with your payments or want to take advantage of lower interest rates, then a cash out refinance may be the better option. Remember to weigh all of the pros and cons before making a decision so that you make the best choice for your individual situation.
If you are interested in finding out which option is the right one for you and how much you qualify for, contact Andes Mortgage today.
Our experts can help you understand the ins and outs of cash out refinancing and HELOCs so that you can make the best decision for your needs. We’ll also provide you with a personalized quote based on your unique financial situation.
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