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As always, we encourage anyone who is thinking of obtaining a mortgage to seek advice from financial professionals who can analyze your personal situation and provide the best possible guidance for you. If mortgage rates aren’t favorable but you still need cash, it’s probably best to leave your first mortgage untouched and add a second mortgage behind it. That way the interest rate on your first mortgage remains intact. A cash-out refinance is a replacement of your existing mortgage. The main thing to know about a home equity loan is that it functions like a second mortgage on your home.
Read on to learn more about these types of loans, how they are similar, and how they are different. If you use a home equity loan to make improvements to your primary residence, you might be able to deduct the loan interest on your taxes. One use of a cash-out refinance is to renovate or make improvements to your home that can increase its value in the long term. If you have a lot of debts to pay each month, borrowing against your home equity and consolidating your debts can reduce the number of bills you have to worry about. But they can be a savvy option for people looking to borrow a large amount of money without having to deal with multiple loans. Bankrate’s editorial team writes on behalf of YOU – the reader.
Risks of home equity loans and how to avoid them
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In this blog post, we’ll take a closer look at the difference between cash-out refinance and a home equity loan. Cash-out refinances are also generally easier to qualify for than home interest loans and offer a longer period to pay back the debt, sometimes even more than the 30 years of a typical mortgage. A cash-out refinance pays off the remaining balance on your first home loan and replaces it with a new mortgage loan. The newly refinanced loan amount is for the remaining debt owed on the first mortgage, plus the amount you’re “cashing out” from the equity. Refinance loans are generally easier to qualify for because they’re a first-lien loan.
Restrictions On Your Loan
Mortgage refinancing simply replaces your existing home loan with a new one. If you take out a home equity loan, however, you will be creating a new loan that must be paid in addition to your current mortgage. In many cases, you could pay a higher interest rate for a home equity loan because lenders perceive it as a higher risk. Home equity is a type of profit (in tax jargon, it’s called a "capital gain") that you realize only when you sell your house. So the money you get from a cash-out refinance, HELOC or a home equity loan isn't taxable because it’s borrowed money you have to pay back. A cash-out refinance replaces your original mortgage with an entirely new loan that's greater than what you currently owe.
HELOCs operate on adjustable interest rates, and the repayment period is about years. This is beneficial because your monthly payments will be predictable. Home equity loans require you to repay in fixed monthly payments that consist of principal and interest. Repayment term lengths are flexible, ranging from five to 30 years, depending on the lender. Both types of loans have limits on how much a homeowner can borrow.
How much are home equity loan closing costs?
Unlock a home equity loan (that requires the borrower to pay interest on the entire loan amount, whether it’s used or not), a HELOC requires that you only pay interest on the amount you use. Some lenders charge an inactivity fee if you don’t use your HELOC funds, so be sure to understand the terms of the loan. Check out these HELOC Requirements to help you decide which loan is right for you. Having access to cash lets homeowners benefit from their money, by paying off high interest debt or paying for their own or a child’s college tuition. Cash-out can be used to put yourself in a better financial position. Texas law says that if you tap into your home’s equity, you can’t do so again until you’ve paid off the first loan.
You usually pay a higher interest rate or more points on a cash-out refinance mortgage, compared to a rate-and-term refinance, in which a mortgage amount stays the same. Cash-out refinances are first loans, while home equity loans are second loans. Cash-out refinances pay off your existing mortgage and give you a new one.
Bottom line: Is a cash-out refi or a home equity loan right for you?
With a HELOC, you gain instant access to a specific amount of funds, which you can borrow at any time during the draw period, which might be five to 15 years. Once the draw period ends and the repayment starts, you begin making payments that include principal. While interest rates on home equity loans are lower than those for personal loans or credit cards, they are higher than rates on first mortgages. This is because the home equity loan is in a secondary position behind your original mortgage, meaning it is second in line for repayment in the event of a default. A HELOC typically comes with an initial draw period of five to ten years during which you can use the available credit, much like a credit card.
You may also want to look into a home equity line of credit to determine whether a HELOC or cash-out refi makes more sense for you. Since cash-out refinances are first loans (meaning they’ll be paid first in the case of a foreclosure, bankruptcy or judgment), they typically have lower interest rates. You might be able to do a cash-out refinance if you’ve had your mortgage loan long enough that you’ve built equity. But most homeowners find that they’re able to do a cash-out refinance when the value of their home climbs. If you suspect that your home value has risen since you bought your home, you may be able to do a cash-out refinance. A home-equity loan is a lump sum that you borrow against your home’s equity when you’re in need of extra funds.
During this draw period the monthly payment is usually interest-only, which allows for a more affordable monthly payment. Since mortgage interest rates are tax deductible , a home equity loan or HELOC could lower your taxable income and help you secure a larger tax refund. While you can spend that money on pretty much anything, Zillow recommends using it to improve your financial situation by paying down debt or renovating your home.
Home equity loan rates may be higher than other refinancing options. The differences, however, vary significantly from bank to bank and over time. Home equity loans typically have a repayment period of up to 30 years.
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