Title: “Maximizing Home Equity: The Ultimate Choice”
The value of home equity has reached unprecedented levels. If you have diligently been repaying your mortgage, you likely have accumulated a considerable amount of equity. According to data from the Federal Reserve, American homeowners collectively possess a remarkable $48.2 trillion in home equity as of 2024. You may now be contemplating whether it is the right time to leverage some of your own equity.
There are two primary methods to access the cash tied up in your home: a cash-out refinance or home equity loans, including Home Equity Lines of Credit (HELOCs). These funds can be utilized for various purposes such as home improvements, debt consolidation, or covering educational expenses. However, in the current high-rate climate, Matt Weaver, a loan originator at CrossCountry Mortgage in Florida, advises caution. He suggests that only those who have a more beneficial use for the funds should consider tapping into their equity. This could involve financing home renovations instead of purchasing a pricier property, or consolidating significant credit card debt with high interest rates that would otherwise take years to repay.
With this advice in mind, we will delve into how cash-out refinancing and home equity loans function, the factors to take into account, and alternative financing options to determine the most suitable choice for your financial circumstances and borrowing needs.
Cash-Out Refinance Overview:
A cash-out refinance involves replacing your current mortgage with a larger one, allowing you to receive the surplus cash in your bank account. The new loan pays off your existing mortgage, and you obtain the additional funds, minus closing costs, upon loan closure. Cash-out refinances typically offer 15- or 30-year terms with fixed or adjustable rates. Unlike home equity loans that introduce an additional payment to your budget, a cash-out refinance results in a single new mortgage payment that replaces your previous loan’s payment.
To qualify for a cash-out refinance, most lenders typically require:
– A credit score of 620 or higher (with better rates for scores of 680+)
– Up to 20% equity remaining post-refinance
– Debt-to-income ratio below 43%
– Proof of stable income
– Good payment history
Determining the Equity Available:
Your equity is the variance between your home’s value and the outstanding mortgage balance. For instance, if your home is valued at $400,000 and you owe $250,000, your equity amounts to $150,000. However, conventional loans usually necessitate maintaining at least 20% equity post-refinancing. For a $400,000 home, this means retaining $80,000 in equity, leaving $70,000 accessible for borrowing. VA and FHA loans may offer more flexibility, potentially enabling eligible borrowers to access 90% to 100% of their home’s value.
Benefits of a Cash-Out Refinance:
A cash-out refinance presents certain advantages that may justify pursuing this option, particularly
When you want to extend your repayment period and borrow more money, consider a cash-out refinance with terms up to 30 years. While spreading your payments out over a longer duration may lead to higher total interest payments compared to a 15-year term, some lenders may waive refinancing costs if you refinance now and then again later when rates drop. This option can alleviate concerns about refinancing too soon or missing out on better rates in the future.
However, there are drawbacks to a cash-out refinance, such as higher closing costs ranging from 2% to 5% of the loan amount, reduced equity in your home, resetting your loan term to 30 years, and a more complex application and approval process compared to home equity loans or HELOCs.
Home equity loans (HELoans) are second mortgages that allow you to borrow against your home’s equity while maintaining your original mortgage. These loans offer fixed rates and terms of 5 to 20 years with lower or no closing costs. On the other hand, a home equity line of credit (HELOC) operates like a credit card with a variable rate, allowing you to borrow and repay funds during a draw period of 5 to 10 years.
Qualifying for a home equity loan or HELOC typically requires a credit score of 620 or higher, at least 15% to 20% equity in your home, a debt-to-income ratio below 43%, stable income history, and a good payment record.
Home equity loans and HELOCs are beneficial for homeowners who wish to retain their existing mortgage rate while accessing their equity. They offer the advantages of keeping your original mortgage rate, lower closing costs, and a quicker closing process compared to cash-out refinances.
Consider taking advantage of falling rates with a Home Equity Line of Credit (HELOC) as it offers variable rates that could lead to decreased payments in a declining interest rate environment. However, it’s important to be aware of the drawbacks of home equity loans and HELOCs. These products may have higher interest rates compared to first mortgages or cash-out refinances, as they are considered riskier for lenders. Additionally, managing two separate payments each month for your original mortgage and the home equity loan can be challenging. Borrowing against your home’s equity also reduces your ownership stake and puts your home at risk of foreclosure if payments are missed. When deciding between cash-out refinancing and home equity products, consider factors such as immediate fund access, amount of equity needed, desired loan term, closing costs, and length of time planning to stay in your home. Cash-out refinancing may be more suitable for accessing a large amount of equity, while home equity loans or HELOCs may be better for smaller amounts, lower closing costs, and faster closing processes.
Home Equity Loan (HELOC) Comparison
Loan Type:
– Home Equity Loan: Replaces existing mortgage with larger first mortgage
– Second mortgage with fixed terms
– Second mortgage that works like a credit line
Interest Rate:
– Home Equity Loan: Fixed or variable rate
– Second mortgage with fixed terms: Fixed rate
– Second mortgage that works like a credit line: Variable, with the potential option for a fixed interest rate
Average Rates:
– Home Equity Loan: 7.00% (30-year term)
– Second mortgage with fixed terms: 8.45%
– Second mortgage that works like a credit line: 8.28%
Disbursement:
– Home Equity Loan: Lump sum at closing
– Second mortgage with fixed terms: Lump sum at closing
– Second mortgage that works like a credit line: Flexible draws as needed during draw period (typically 5 to 10 years)
Term Length:
– Home Equity Loan: 15 to 30 years
– Second mortgage with fixed terms: 5 to 30 years
– Second mortgage that works like a credit line: 5- to 10-year draw period + 20-year repayment period
Closing Costs:
– Home Equity Loan: 2% to 5% of loan amount
– Second mortgage with fixed terms: Low or no-cost options available
– Second mortgage that works like a credit line: Low or no-cost options available
Best For:
– Home Equity Loan: Large, one-time expenses
– Second mortgage with fixed terms: Large, one-time expenses
– Second mortgage that works like a credit line: Ongoing or uncertain expenses
Risk Factors:
– Home Equity Loan: Resets entire mortgage term; high closing costs
– Second mortgage with fixed terms: Second payment to manage; higher interest rate
– Second mortgage that works like a credit line: Second payment to manage; payment shock when draw period ends
Consider These Alternatives:
– Personal loans
– 0% intro APR credit cards
– Reverse mortgage
– 401(k) loans
– Government-backed renovation loans
– Life insurance policy loans
– Home sale and downsizing
For more information:
– FAQs: Home equity, refinancing and protecting your money
– Comparison of a home equity loan and a cash-out refinance
– Equity requirements for mortgage refinancing
Refinancing without private mortgage insurance may be an option if you have good to excellent credit. Some lenders and certain mortgage types, such as FHA and VA loans, could allow you to refinance with less equity involved. To delve deeper into the subject of timing your mortgage refinance, refer to our comprehensive guide.
Regarding the application process, it is permissible for a lender to inquire about your age. However, it is illegal for them to reject your application solely based on your age. Your date of birth is typically requested as part of the standard personal information needed by a lender or creditor. While age may be a factor considered alongside other aspects like income and credit score, it cannot be the sole reason for denying you a loan or credit. The only age-related requirement is that applicants must be at least 18 years old. To gain more insights, explore our detailed guide on mortgage approval during retirement.
In a cash-out refinance scenario, it is possible to lose equity. For instance, if your home is valued at $400,000 and you have an outstanding mortgage balance of $200,000, your equity stands at $200,000. Opting for a cash-out refinance of $250,000 would diminish your equity to $150,000 as you are borrowing an additional $50,000.
As for home equity loans, many lenders typically necessitate an appraisal to ascertain the current value of your home. However, individuals who have recently purchased a home and boast excellent credit may have the opportunity to secure a no-appraisal home equity loan from select lenders. These loans leverage digital tools and hybrid models to evaluate various aspects of your home, including its features and comparable sales in your neighborhood, to determine its value. Consider exploring specialized digital lenders like Figure or LoanDepot for such offerings and familiarize yourself with the process by referring to our guide on no-appraisal home loans.
For further details and statistics, references from trusted sources like Realtor.com and Bankrate have been included in this article. Additionally, the writer of this piece, Kat Aoki, is a seasoned finance professional with a wealth of experience in producing informative content on various financial topics. Her work has been featured on reputable platforms such as Lifewire and Finder, establishing her as a reliable source of knowledge in the realms of technology, fintech, banking, lending, and investments. Kat’s primary goal is to equip consumers and business owners with the necessary information to make well-informed decisions when selecting financial products that align with their requirements.
