We have all seen the ads regarding tapping into your home equity to achieve your dreams. Young couples standing in front of fantastically remodeled kitchens and bathrooms or sitting on a backyard deck oasis. Yes, this is certainly possible if you utilize your home equity for home remodels and repairs. Too good to be true?
Like all good things in life, it’s certainly not free. Financial institutions will charge various fees to get a loan started. Additionally, interest paid for the life of the loan. In certain situations it makes financial sense to tap into your equity, in others it may not be the best financial, but a solid personal decision.
Loan Types
Two mainstream loan products exist to tap into your home equity. Cash out refinance, and Home Equity Line of Credit (HELOC). While both ultimately achieve a similar goal, their use cases are unique.
Cash out Refinance
The cash out refinance option is most popular in a falling interest rate environment. The reason for this is those taking advantage of this loan are effectively re-purchasing their home at the current interest rate of the day. The goal is often to re-start your loan at a lower overall rate and take out additional cash to use to pay off high interest debt, initiate a home remodel, or meet a financial need. If you can hit a sweet spot on cash out amount and rate, you can often maintain a similar, or, lower monthly payment while pocketing cash from your homes appraised value.
Keep in mind, nothing in this world is free. Even if you get a lower rate and payment, you are still restarting your loan term. If you refinance at year 10 into your 30 year mortgage, you are now at square 1 if you take out a 30 year note.
Numerous factors play into your eligibility to refinance your home including home value, credit score, and income. In general the same rules apply as if you were initiating a conventional mortgage, however, the “down payment” is effectively your home equity (value of your home less amount owed).
Just about any mortgage lender is able to perform a cash out refinance to those who qualify and the market is extremely competitive which gives you, the borrower, leverage. Shopping multiple lenders is imperative to getting the best deal. A pro tip the interest rate is only part of the story. To truly compare, request a loan estimate from multiple lenders and compare the monthly payment as lender fees can vary greatly on this product.
Home Equity Line of Credit (HELOC)
A home equity line of credit is a much simpler version of the cash out refinance and a solid option if you need cash quickly but do not want to restart your mortgage. It allows you to borrow a percentage of your homes value for whatever uses you deem necessary. Once repaid, you can keep the line open for future use or close it out.
A drawback of a HELOC is that it often has a higher interest rate than a full cash out refinance which means it will cost more in monthly interest to borrow. Keep in mind, that is only a part of the story. The higher interest rate is not coming with fully re-starting your mortgage loan which could mean years of interest payments. It may make more financial sense to take out a HELOC at a higher rate and repay in 24 months versus a cash out refinance and repay over 30 years. For many who are locked into low interest rates from the early 2020’s, a HELOC is a no brainer to get cash out of your home and keep your low APY.
If on the fence between the two, find a mortgage lender that can service both products so that they can advise you on the pros and cons of your specific situation.
