If you’ve been paying down your mortgage for a while, there’s a good chance that you’ve built up some equity. Plus, with increasing house prices across the country, your property’s value has likely gone up, which can also give you an equity boost. The question is, can (and should) you tap into your home’s equity? If you need some cash to fund a home improvement project, pay off debt, or cover a large expense, it could be time to consider a cash-out refinance or HELOC. Here’s what that means.
Equity is the difference between what your home is worth and how much you owe on it. For instance, if your home is valued at $550,000 on the current market and you owe $125,000, you have an astounding $425,000 in equity.
The more your property value increases and the more you pay down your mortgage, the more your equity grows. Of course, it can feel quite useless to you if you don’t know how to leverage your home’s equity to help you meet your other goals.
Two ways to tap into your home’s equity are a cash-out refinance and a HELOC. Both allow you to get a big cash lump sum based on the amount of equity you have in your home, but they take a different approach. To make sure you know the risks and make the best decision for your situation, here’s a breakdown of these two options.
A cash-out refinance allows you to get a lump sum of money now and pay it back over time. In simple terms, a cash-out refinance accomplishes a few things:
- Pays off the balance on your existing mortgage.
- Gives you a lump sum of money based on your equity.
- Rolls that lump sum amount and mortgage payoff into one new monthly payment.
- Allows you to change the type of mortgage you have (for example, fixed-rate to adjustable rate or vice versa).
By refinancing your existing mortgage, you could potentially get a lower interest rate or negotiate a longer payback term, which could lower your monthly payment. However, you’re also paying back that lump sum of money as part of your new contract.
HELOC stands for “home equity line of credit,” and it functions quite differently from a cash-out refinance. It’s also different from a home equity loan. You could treat a HELOC much like a credit card, because it is a line of credit. Here’s what you should know:
- A HELOC is a line of credit, not a loan.
- Borrow money as you need it during the draw period.
- You must pay back all the money you borrowed during the repayment period.
A HELOC does not impact your existing mortgage on your home, but instead creates a “second mortgage.” This simply means that your home is used for collateral by the lender, which gives them rights to foreclosure if you fail to repay your HELOC as agreed.
As you can see, there are countless differences between a cash-out refinance and a HELOC. However, comparing these options side by side can help you decide what’s best for your situation.
A cash-out refinance is ideal if you are hoping to lower your interest rate or extend your payment term on your current mortgage. Additionally, it rolls the repayment for the lump sum of cash into a single monthly payment, so you can continue paying off your home with ease.
On the other hand, a HELOC is a “second mortgage,” which means you will have to continue paying on your original mortgage and make a second payment to cover any money you borrow through the HELOC. If your current mortgage does not have ideal terms, you would have to refinance it separately to improve them.
If you’re looking to pay off debt, finance a big project, or cover a major life expense, you might like the fact that a cash-out refinance gives you a lump sum of cash up-front. With that money in hand, you can use what you need as you see fit. If you end up not needing as much as you borrowed, you could simply turn it around and put it towards your principal loan balance.
On the other hand, many people like the convenience of a HELOC because they can treat it like a credit card. You can borrow the full amount all at once or you can simply take out what you want as the need arises. Additionally, a HELOC will generally offer much more favorable interest rates than a credit card.
A cash-out refinance rolls the repayment of your lump sum into the life of your new mortgage, which could be up to 30 years. Meanwhile, a HELOC works in two phases: the draw period, in which you can take money out while just paying the minimum, and the repayment period, in which you can no longer take money out.
Most HELOCs give you a 10-year draw period. During that time, you can repay any amount previously borrowed to increase your line of credit. Alternatively, you can choose to make interest-only or minimum payments. Once you enter the repayment period, you can no longer take out money, but you generally have up to 20 years to pay the borrowed sum back.
Tapping into your home’s equity could be a smart idea, however it depends on how you go about it. For some, the chance to refinance their home and get a lump sum payment is perfect for their financial goals. For others, the flexibility of a HELOC and the ability to keep their original mortgage is appealing.
Ultimately, the best thing to do is compare your options. Understanding the interest rates, loan terms, and total equity that you can leverage is essential to helping you decide on the right way forward. Fortunately, LemonBrew can help. With LemonBrew Lending, top-tier loan experts can compile the best offers for you so that you can refinance and get on the way to your goals. Get started today!