In this article
If you are looking to make home improvements and you have some home equity built up in your property, you have several loan options to consider. Your best solution may depend on how much you need to borrow, when you need to borrow it and what type of mortgage loan for which you qualify.
Today, we are going to compare the differences between cash-out refinancing and a home equity line of credit (HELOC). Both options have some pros and cons. Both can be very viable solutions to finance home improvements.
Why Borrow From My Home Equity?
This is a good first question to ask yourself. If you don’t need to cash out any home equity, then there’s no reason to consider these loan options. Leave your money in your house or condo and let the equity keep growing. It will only give you more leverage later—as well as more profit when you are ready to sell your home.
Using funds borrowed from your home equity is a smart idea if you are looking to finance home improvements. Of course, these improvements may end up increasing the value of your property and helping to restore any equity that you took out—possibly even more. It makes sense to borrow against your existing home equity because the money is basically already there. It is not borrowing from a bank who is pulling the funds from other sources. You have earned your equity as a homeowner who is current on mortgage payments, so why not leverage it into a cash loan?
Using your home equity as collateral removes a lot of risk for your mortgage lender. Therefore, you can qualify for lower interest rates and better payoff terms with either a cash-out refinance or a HELOC.
The Basics of Cash-Out Refinancing
A cash-out mortgage refinance is a special type of home loan that allows you to refinance your current mortgage loan while also cashing out some of your home equity. The new loan total (the principal amount you still owe plus the equity you cash out) will be rolled together into one mortgage. This means one easy monthly payment moving forward, plus cash in your hand to spend as you see fit. Paying for home upgrades and repairs is one of the most common uses for cash-out refinancing.
Cash-out refinancing can provide better mortgage rates than most standard home equity loans (aka “second loans”) and home equity lines of credit (HELOCs). Not every lender offers cash-out refinance loans and not every borrower will qualify. You will need a solid financial standing (good credit score, steady income, reasonable debt, etc.). And, of course, you will need to have ample home equity built up in your property. The lender will authorize a home appraisal to calculate your house’s current market value and that will help determine how much you can cash out.
The Basics of HELOCs
A home equity line of credit is similar in the sense it allows you to borrow money using your home equity as collateral. Again, it provides little risk to the lender because the money is already there in your property. A HELOC is kind of like a credit card that allows you to withdraw cash or use your credit as you need it—rather than one lump sump payment like cash-out refinancing or home equity loans.
Your mortgage lender will authorize your credit limit and then you can decide when and how you want to use the money. The credit line will generally be open for a certain amount of time and you will have more flexibility in terms of paying back any funds you borrow.
HELOCs are very popular among homeowners who want to make home improvements, especially when they plan to spread out the projects and don’t necessarily need all the money at once. It allows you to take care of a few things at a time rather than one massive renovation. You can budget and withdraw funds as you go. If you change your mind about something, you won’t have a bunch of money leftover. You take what exactly you need when you need it.
Mortgage Rates—Cash-Out Refinancing vs. HELOC
Cash-out refinancing generally offers lower mortgage rates compared to HELOCs. HELOCs will offer better interest rates than home equity loans. Cash-out refinancing is a great option if you qualify for a lower rate than you are currently paying on your original mortgage loan. You can refinance at a lower mortgage rate and cash out some money at the same time—all together as one new loan.
Should I Apply for a Cash-Out Refinance or HELOC?
The answer here will depend on several factors:
• How much money do I need to borrow?
• When do I need the money (lump sum vs. credit line)?
• When can I start paying back the loan?
• How am I using the money?
• Which option do I qualify for?
That last question is important because not everyone will qualify for cash-out refinancing. More homeowners can usually qualify for HELOCs or home equity loans. Talk with a mortgage lender who offers all of these options—along with other home improvement loan options like FHA 203k rehab loans or Fannie Mae HomeStyle loans. See which solution is best for you and get pre-approved at the lowest possible mortgage rate.