If you are interested in borrowing against your home’s available equity, you have choices. One option would be to refinance and get cash out. Another option would be to take out a home equity line of credit (HELOC). Here are some of the key differences between a cash-out refinance and a home equity line of credit:
Loan Terms
* Cash-out refinance pays off your existing first mortgage. This results in a new mortgage loan which may have different terms than your original loan (meaning you may have a different type of loan and/or a different interest rate as well as a longer or shorter time period for paying off your loan). It will result in a new payment amortization schedule, which shows the monthly payments you need to make in order to pay off the mortgage principal and interest by the end of the loan term.
* Home equity line of credit (HELOC) is usually taken out in addition to your existing first mortgage. It is considered a second mortgage and will have its own term and repayment schedule separate from your first mortgage. However, if your house is completely paid for and you have no mortgage, some lenders allow you to open a home equity line of credit in the first lien position, meaning the HELOC will be your first mortgage.
How You Receive Your Funds
* Cash-out refinance gives you a lump sum when you close your refinance loan. The loan proceeds are first used to pay off your existing mortgage(s), including closing costs and any prepaid items (for example real estate taxes or homeowner’s insurance); any remaining funds are yours to use as you wish.
* Home equity line of credit (HELOC) lets you withdraw from your available line of credit as needed during your draw period, typically 10 years. During this time, you will make monthly payments that include principal and interest. After the draw period ends, the repayment period begins; you are no longer able to withdraw your funds and you continue repayment. You have 20 years to repay the outstanding balance.
Interest Rates
* Cash-out refinance is available through either a fixed-rate mortgage or an adjustable-rate mortgage. Your lender can provide information about fixed-rate and adjustable-rate mortgage options, so you can decide which one best fits your situation.
* Home equity line of credit (HELOC) has an interest rate that’s variable and changes in conjunction with an index, typically the U.S. Prime Rate, as published in The Wall Street Journal. Your interest rate will increase or decrease when the index increases or decreases. Your lender may also offer you a fixed-rate loan option that would allow you to convert all or just a portion of the outstanding variable rate balance to a fixed-rate loan.
Closing Costs
* Cash-out refinance incurs closing costs similar to your original mortgage.
* Home equity line of credit (HELOC) usually has no (or relatively small) closing costs.
If you think that borrowing against your available home equity could be a good financial option for you, talk with your lender about cash-out refinancing and home equity lines of credit. Based on your personal situation and financial needs, your lender can provide the information you need to help you choose the best option for your specific financial situation.
Melanie Sedam is the owner and a loan originator at The Paseo Group, and she can be contacted at 520-829-5219 no. 1.