A mortgage is like a forced savings account. Homeowners accrue equity in their home as they make the initial down payment, pay down their home loan, and improve their property over time. When you pay your monthly mortgage payments, you pay down both the loan’s interest and its principal (the amount of the loan). Each payment increases the amount of equity — or the portion of the house’s value you own — you have in your home. In the event of an emergency or an opportunity to improve your home, you can take a loan out by using the equity you’ve built in your home over time.
There are three traditional ways to access your home’s equity:
- Cash-out refinancing
- Home equity loans
- Home equity lines of credit (HELOC)
Knowing the difference between refinancing and home equity loans, as well as the different advantages of each option, will help you make the best financial decisions for your unique situation.
Cash-Out Refinance vs. Home Equity Loans
Here are the main differences between a cash-out refinance and a home equity loan:
What Is a Cash-Out Refinance?
In a cash-out refinance, you replace your existing mortgage with a brand-new one at your home’s current value. You can also take cash out, which can be any amount up to the value of the equity you have in your home. Refinancing your home creates an effective “restart” on your home loan.
For example, you’ve been regularly paying the mortgage on your home (which you purchased for $250,000) for several years, and you’ve paid down $100,000 of the loan’s principal (which is 40%). This leaves your current mortgage balance at $150,000 (though fees and interest will increase this total). Any amount above that remaining balance is eligible for a cash-out refinance. However, finance experts suggest you should keep at least 20% of your equity after refinancing, so you would limit yourself to $50,000.
What Is a Home Equity Loan?
With a home equity loan, also known as a second mortgage, you borrow against the equity you have in your home. For example, on a $250,000 house, you can borrow a percentage of that $100,000 equity in your home based on the agreement you reach with your lender. This is a second, separate financial agreement from your mortgage, and the amount you can borrow depends on your equity, credit score, and other financial markers. Homeowners with a mortgage and a home equity loan will make payments on those two loans throughout the life of both.
Home Equity Loan vs. Refinance: What’s the Better Option?
Despite the differences between refinancing and home equity loans, both loan options are valuable tools for homeowners. They give you access to large amounts of cash if you have significantly invested in your home.
However, home equity loans are simpler and have lower closing costs than a complete refinance. Some advantages of cash-out refinancing include:
- It has more flexible requirements regarding credit scores and debt-to-income ratios.
- Refinancing can improve your loan terms, such as reducing a previously high interest rate.
Ultimately, a personal finance or home equity professional can help you with any questions. When it comes to refinance vs. home equity loans, it’s important to choose the right route for your circumstances.
The Difference Between a HELOC and Cash-Out Refinance
Home equity lines of credit (HELOCs) are more flexible than home equity loans and cash-out refinances. Through a HELOC, a financial institution will allow you access to a capped line of credit from which you can borrow. Homeowners with HELOCs can spend only what they need instead of worrying about interest payments for excess loan principal amounts.
Key differences in a HELOC vs. a cash-out refinance include:
- Cash availability: A HELOC is similar to a line of credit with a credit card. You can be approved for a maximum amount of credit and then borrow money as needed, provided you stay under your limit. This form of credit is often used by homeowners who are renovating their homes or taking on other large projects with unpredictable expenses. However, you can use your HELOC for any purpose. A cash-out refinance, on the other hand, lets you pull all the equity out of your home in a lump sum.
- Payment structure: HELOCs generally have a draw period and a repayment period. During the draw period, borrowers can either pay back the principal and the interest or just the interest.
- Impact on your mortgage: While a HELOC lets you borrow money, it doesn’t change your mortgage. It simply extends another line of funds for your home renovation or improvement project. A cash-out refinance does replace your mortgage with an entirely new loan agreement.
- Budgeting: Choosing a cash-out refinance or HELOC depends on your circumstances. HELOCs are an additional loan. So homeowners need to be able to manage both the mortgage and HELOC payments at the same time.
However, having a line of credit can help homeowners streamline their decision-making process when they’re in the middle of an investment opportunity or remodeling project. They don’t need to worry about securing a personal loan or missing out on opportunities because their assets aren’t liquid.
Which Is Better: HELOC, Refinance, or Home Equity Loan?
The best method for tapping your home equity depends on your circumstances. If a HELOC, refinance, or home equity loan isn’t a good fit for your finances, there are alternative options, like a Home Equity Investment (HEI) from Point. With an HEI, you can unlock up to $350,000 in home equity with no monthly payments. The qualification requirements are also more flexible, so you might be eligible even if your credit isn’t perfect.See how much you can get and consult with one of Point‘s home equity experts today. We’ll help you figure out the best way you can leverage your home equity for your financial goals.Tags: Home Equity