You spent a ton of money to get your home and that makes it a huge investment opportunity. Every time you make a payment, you gain equity in your home. Your equity grows even faster in an environment where home values are rising, as they are now.
That equity can be converted into cash to unlock the true investment potential of your home. It can be used to pay off home improvements, augment a college fund or give your retirement fund a boost. In this post, we’ll go over your options for making your equity work for you, including home equity loans and cash-out refinances.
Home Equity Loans
One of the more popular options to take advantage of your home value is a home equity loan. However, while you may be aware that it exists, what are these loans and what are the pros and cons?
What Is a Home Equity Loan?
Your stake in your home has been built up over time as you make payments as well as when your home increases in value after you purchase it. A home equity loan involves converting this value that’s been built up into a financial instrument that can help you accomplish a goal.
Unlike the cash-out refinance, a home equity loan is a second mortgage taken out in addition to a primary mortgage.
Pros and Cons of a Home Equity Loan
Now that you know what it is, let’s go over the points for and against home equity loans. Although cash-out refinances serve the same purpose, they each have advantages and disadvantages based on the way the loans are structured.
These allow you to take advantage of the home equity you’ve currently built up by taking out a second mortgage against your existing home equity – the amount of your loan that’s currently paid off – in order to make home improvements, for example. There may be limits set by lenders or investors in the loan regarding how much of this existing equity you can take a loan against.
The upside to this is that you have the option to go with a fixed payment. That way, your payment never changes, and you know what you’re getting.
Home equity loans also give you the flexibility to hold onto the existing rate and term of your primary mortgage if you’re happy with it. Some would rather have the flexibility of paying on a separate loan rather than touch their primary mortgage.
If you’re looking to purchase a home, sometimes people will choose to take a primary mortgage and then use a secondary mortgage so they can bring their total equity down to 80% and avoid paying for mortgage insurance. It depends on the client, but doing this may sometimes be cheaper than the mortgage insurance policy. Be aware that if you’re going to do this, your lender may require you to make a slightly higher down payment (e.g. 10% or more) in order to have the option to take a second mortgage on a purchase.
There are downsides. With home equity loans, you’re going to pay a higher rate than you would if it were your first mortgage since home equity loans are a second mortgage.
The reasoning for this is that lenders assume that you’re going to make the payment on your primary mortgage first. The lender that made the home equity loan also gets a lien on your house, but the primary lender’s lien takes precedence. In exchange for the additional risk, the lender on the second mortgage will charge you more.
Additionally, home equity loans taken out to do things other than build, buy or improve your home don’t feature tax-deductible interest after the 2017 tax year.
The last downside is that you have two mortgage payments to worry about. It can complicate things.
Quicken Loans doesn’t offer home equity loans at this time.
Every situation is different, so we always recommend talking to a financial advisor. In many cases, however, the best option for utilizing your home equity is going to be a cash-out refinance. It features many of the benefits of the other two options but also has a couple of key advantages. But first, let’s go over some basics.
What’s a Cash-Out Refinance?
Like home equity loans, you utilize your existing home equity and convert it into money you can use in a cash-out refinance. The difference here is that you aren’t taking out a second mortgage. It’s your primary mortgage.
How Does a Cash-Out Refinance Work?
With any of these loans, the more equity you have, the more you can take and convert to cash if you need it. With a cash-out refinance, it’s especially important to take this into consideration. Why?
When you take cash out of your primary mortgage, you have to leave a certain amount of equity in your home. The exact amount depends on the type of loan you’re using.
With a conventional loan, you need to leave 15 – 20% equity in your home. FHA loans allow you to leave just 15% equity, but you’ll have to pay mortgage insurance premiums, so it’s something to think about. Finally, if you’re an eligible active-duty service member, veteran or surviving spouse, you can actually take out a loan for up to 100% of the appraised value of your property. This gives you the opportunity to maximize the impact of a renovation college fund or retirement savings boost.
Pros and Cons of a Cash-Out Refinance
As with home equity loans, if you take cash out, there are pros and cons. Let’s run through them.
The first big advantage here is because you only have one mortgage against your house. That means there’s less risk for the lender and you’ll get a better rate than you would if it were a second mortgage.
It may also be preferable because you only need to budget for one mortgage payment every month. This could help simplify your finances.
Cash-out refinances are often the best way to consolidate debt because they’re based on your primary mortgage, you’re getting the lowest possible mortgage rate for your financial profile. Mortgage rates recently have been in the high 4% to low 5% range for a 30-year fixed.
The average credit card interest rate is currently in the high teens.
By taking cash out to pay off high-interest debt like credit card balances, you can potentially save yourself a lot of money when compared to paying off the balances incrementally over time.
A cash-out refinance is also good for helping you accomplish other financial goals because of the relatively low interest charges. These may include boosting a college or retirement fund or getting home improvements done.
While you can get the lowest rate on your loan because it’s tied to your primary mortgage, this also has its disadvantages.
As discussed above, if you want to take advantage of a cash-out refinance, you usually have to leave a minimum amount of equity within the home. Because of this, it’s very important to make sure that you can take out enough home value to accomplish your goal. If you don’t have enough equity to get the job done, you might take a look at alternatives like a second mortgage or personal loan.
Although the lowest rates for taking cash out are available to those who refinance their primary property, some people may wish to take a second mortgage if they really like their primary mortgage rate and don’t want their payment to change.
Which One Is Right for Me?
So, given everything we’ve gone over, is the best option for you a home equity loan or cash-out refinance? The answer very much depends on your personal situation. We absolutely recommend speaking with a financial advisor. However, we can take this space to briefly summarize some of the key points to consider.
A home equity loan might be good if:
- You want to access your home’s value without affecting your primary mortgage
- You’re using a second mortgage to avoid paying for mortgage insurance
- You’re using it in place of or in combination with a cash-out refinance in order to access more of your home’s value
A cash-out refinance is best if:
- You have plenty of equity to accomplish your goal and you want the lowest rate
- You’re attracted to the low rate for debt consolidation purposes, home improvement or fortifying investments
- You would like to keep a single mortgage payment
Now that we’ve reached the end of this article, you should have a better idea of the differences between a home equity loan and cash-out refi as well as some of the factors that go into determining which is right for you. If you’re ready to get started, you can apply online here or give us a call at (800) 785-4788. If you still have questions, you can leave us a note in the comments below.
If you don’t want to tap into your home equity or don’t have enough built up to accomplish your financial goals, a personal loan could be a good option that might make more sense for your financial situation. Our friends at Rocket Loans® offer personal loans up to $45,000.
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