Millions of home owners today like to tap the equity in their home to pay for things they want or need with a cash out home equity loan, refinance or HELOC. One of the big reasons is that homes are appreciating in value; in 2015, homes in the US on average grew in value by more than 6%.
From home renovations to college tuition to a new car, there are many big-ticket expenses that many people can only afford by using the equity in their property.
There are several basic ways for home owners to use the equity in their houses that we will detail in this article. They are:
- Cash Out Mortgage Refinance
- Fixed Home Equity Loan
- Home Equity Line of Credit or HELOC
To determine if pulling cash out of your home is for you, it is necessary to explain what each of these types of loans are in detail.
Cash Out Refinancing
A cash out refinance just means that you are refinancing your mortgage to a lower rate for an amount higher than the current balance. You keep some of the difference between the old and new loans – this is some of your equity in the property.
For example, say you want $25,000 to pay for college tuition, but you own $100,000 on a $200,000 home. You can do a cash out refinance on your home at $125,000 and keep the $25,000 of equity to pay for college. And usually, you will be getting a lower home equity interest rate on top of the equity you keep.
A mortgage refinance for cash back have these advantages:
- Pay for large expenses. You can use your equity for whatever you want. The most common uses are home renovations, college and medical expenses.
- Improve your credit score. Using a cash back refinance to pay off credit card debt will increase your credit score. Mortgage debt is scored differently and more favorably than credit card debt, as people are more likely over time to pay their mortgage given that it is their personal residence.
- Lower and more stable rate: Mortgage interest rates are some of the lowest interest rates you will ever pay on a loan. Also, it is a steady rate; usually people refinance into a fixed rate loan. So, you know what your payments will be for many years.
On the down side, your cash out refinance interest rate is going to be a bit higher than your original interest rate because you are pulling out cash, which makes the loan bigger and riskier.
You also need to fully document your credit score, debts, assets and income again just like when you got your original home loan. You also will need to provide your tax returns for the last two years.
Closing costs are another requirement of doing a cash out refinance. Last, your home is at greater risk of foreclosure because you owe more on your loan, which could be more than the home is worth if prices decline.
A cash out refinance could be your best option if you have an interest rate that is higher than current market rates. You do not usually want to refinance unless you are going to be moving into a lower rate.
Home Equity Loan
If you are happy with your current mortgage and interest rate but still want to tap your equity, you have other options. You also may get a second mortgage called a home equity loan.
This is a form of second mortgage that allows you to receive a lump sum payment of a large portion of your available equity. This type of loan is a good move if you have a good interest rate on your first mortgage, and want to pay for something that requires a lump sum payment. For example, you may need to pay for college tuition for a year or a large medical expense. These types of items are good candidates for a home equity loan.
The primary advantage of this type of second mortgage is that it comes with a fixed interest rate. This will be higher than your first mortgage, but it will be considerably lower than personal loan or credit card interest rates. A fixed rate gives you a guaranteed schedule of pay back on the loan, so you know exactly what you will pay and for how long.
On the down side, a home equity loan carries a higher interest rate than the other type of second mortgage, the HELOC loan. Also, as with any cash out loan option, you are putting your home at risk of foreclosure by pulling out equity.
Home Equity Line of Credit
A home equity line of credit is the other type of second mortgage you can choose to get your equity. This type of loan has a variable interest rate, and operates like a credit card. You are given a certain credit limit representing a large portion of your equity in the home. You may draw on that credit line up to the maximum amount.
The interest rate is low at first, but can rise with interest rates depending upon market conditions. Also, interest only payments are common during the draw period, but can increase when you start to pay on principal.
HELOCs are a good choice for people who need to draw on cash over a longer period. A good use of a home equity line of credit is a home renovation. Some home owners also get a cash out HELOC just to have an emergency reserve if they need it.
No matter if you choose a cash out home equity loan, HELOC, or refinance you should be able to write off the mortgage interest on your taxes. This is a major benefit of using home equity instead of credit cards and other unsecured loans. Review the current HELOC rates from competitive sources across the nation.
The Bottom Line
With home prices increasing, more home owners in 2017 are turning to home equity to pay for the things that they need. You should talk to your mortgage broker to determine which type of cash out equity loan is best for you.
References: Pros and Cons of a Cash Out Refinance. (n.d.). Retrieved from http://www.bankrate.com/finance/refinance/pros-and-cons-of-cash-out-refinance.aspx