People often say that there’s no romance without finance. Moreover, you can’t remodel your kitchen, buy a new car, or pay for college without having finances.
Now here’s the truth… some of our biggest investments often require outside help that’s either in the form of a loan or line of credit. According to Zillow, 70% of homeowners owe debt on a mortgage loan.
What is The Best Option For Borrowers Seeking Extra Cash?
If you are a homeowner that needs additional funds to subsidize a big purchase or debt, getting a personal loan with a high-interest rate is not always the best option. Here are better options that people use today: a home equity loan, home equity line of credit (HELOC), or a cash-out refinance.
What is a Home Equity Loan (HEL)?
This type of loan allows you to borrow a fixed amount by using your home as collateral. The lender will give you the money in a lump sum. Moreover, how much money you receive hinges on the loan to value ratio, payment term, verifiable income, and credit history.
In normal cases, a HEL has a fixed interest rate, term, and monthly payment. The amount of interest that you pay on your home equity loan is 100% tax-deductible. It’s important for you to speak with your tax advisor regarding this as well.
Recap – Home Equity Loan:
- Your first mortgage is left alone
- You pay less in acquisition costs than for a cash-out refinance
- The amount of interest on the loan is tax-deductible
- Normally, the interest rate is higher than a cash-out refinance, the fees are higher than a HELOC
Who is this good for?
This is a good option for those who need money for a single case and desire the comfort of fixed-rate loans. In addition to, it’s a good option if you don’t want to refinance but keep your existing mortgage along with receiving a lump sum of money.
What is a Home Equity Line of Credit (HELOC)?
A HELOC is a type of revolving credit that enables people to borrow with their homes being collateral. Lenders approve people by taking a percentage of their home appraisal value and subtracting the balance they owe on the existing mortgage. Lenders will also determine this factor by your income, other debts, and credit history.
Getting a HELOC allows you to spend the money (up to the credit limit) on anything without restrictions via a credit card or special checks. On the other hand, there are plans that place restrictions and guidelines in regards to you borrowing a minimum amount each time, withdraw an initial advance when the line of credit is established, or keep a minimum amount outstanding.
According to Josh Hastings, CEO of Money Life Wax – The pro's of using a home equity line of credit (HELOC) is that unless you plan on selling your home in the near future, equity is a dormant asset. So leveraging your equity to payoff your student loans or even your house quicker is just another reason why leveraging a HELOC is a great idea!
Home Equity Line of Credit plans allow you to withdraw the money you need over a set period of time. This is known as the “draw period”. Moreover, you have the ability to renew your credit line and continue to withdraw money at the end of the period. Don’t be ignorant of the fact that not all lenders allow renewals.
On top of that, there are lenders that demand borrowers to pay back the amount they withdrew at the end of the draw period. Some lenders may grant you the ability to make payments over another time period which is known as the “repayment method”.
Recap – HELOC:
- With a HELOC, by a shoer negotiation, you'll be able to reduce the interest rate to be lower in comparison to a home equity loan (HEL).
- Because of little to no restrictions, they are quicker and easier to secure
- You withdraw the money on an at-need basis and pay zero interest until you do
- Your payments can be high due to the fact that the interest rate is adjustable which means it can rise at any time
Who is this good for?
For those who need extra funds accessible to them over a period of time. For instance, if you’re remodeling, you can withdraw from the credit line periodically to pay the contractors. They also provide a way for people to have access to cash without having to pay interest unless you withdraw from it.
A cash-out refinance is a refinance of your current, existing mortgage loan. This type of refinance allows one to get a new loan to pay off the current one. Moreover, it also takes out the equity (the difference between the worth of your property and how much you owe on the mortgage) via a single, lump-sum cash payment.
A cash-out refinance is also a fixed-rate loan which can last for 30, 20, or 15 years by offering a very low-interest rate. One thing to note is that the current national average rate for a 30-year fixed mortgage is 4.6% even though the rate for a cash-out refinance is higher (especially if you desire to roll the closing costs into the loan amount). This type of refinance also places a new first position lien on your property over the amount that you currently owe.
It’s also good to know that the phrase “first position” points towards the order of the recording by your county clerk, which dictates which mortgage you have to pay first if you default on the loan.)
Recap – Cash-out Refinance
- It enables individuals to lower their current interest rate so they can take advantage of a lower total rate than they would by having a home equity loan or HELOC
- There are only one loan and one payment
- The interest on this type of loan is tax deductible
- The first mortgage is reset, which could add more years to the term until you pay it off in full
- You have to borrow all of the money at a single time and begin making payments immediately every month
- The process of closing can be very long with closing costs being at 7% of the total loan amount (although you can choose a no-closing-cost option that combines your closing costs into a higher interest rate.)
Who is This Good For?
This is a good option for you if you have a lot of equity built up and you want to refinance your entire mortgage. People have many reasons to refinance such as taking advantage of lower rates or changing from an ARM to a fixed-rate loan.
Another good thing to note is that if you plan to refinance and need additional cash, the cash-out refinance solve both problems.
Cash-Out Refi, Home Equity Loan or HELOC – Which is Better?
You have to consider important things before choosing one of these financing options.
Making the right choice is contingent on your current circumstances, the amount you need to borrow, the condition of your existing first mortgage, your income, and cash flow, and your tolerance for risk.
Since HELOC’s are neither subject to Dodd-Frank rules nor truth-in-lending regulations, people can obtain one easily. The next easiest are equity loans. The only deal is this… there are limitations on the sources and they are expensive. Even though a cash-out refinance are difficult to obtain, it’s a good option if you don’t have a big mortgage because they cost less in most cases.
Here’s another tip… before applying for a HELOC or home equity loan, consider the following: the amount of money you actually need, and how you plan on using the money. Also, it’s important to take into account the interest rates, fees, monthly payments, and tax advantages before applying. You can always use our HELOC calculator to get a good estimation of those factors.
The benefit of utilizing the equity of your home before you sell is a powerful tool (benefit) at your disposal. The downside is that you’re using your home as collateral. Here’s the main thing you need to avoid while choosing a HELOC or a loan: Stay away from funding short-term needs that could turn out being a long-term loan.