We can help you make the choice between a HELOC vs. cash-out refinance.
If you’re like most Americans, there’s no bigger purchase you’ll make in your lifetime than buying a home. A home is an investment, and there’s a return on that investment in the form of equity. Yet many homeowners won’t be able to access that equity unless and until they sell their home. So what if you don’t want to sell your home? That’s your equity—shouldn’t you be able to use it?
Since selling your house isn’t a viable solution for everyone, lenders have come up with ways to help homeowners access their home equity so that they can pay for all kinds of things: home renovations, investing in real estate, vacations, car and student loans, and even credit card debt. Your home equity is a precious resource. It’s a wonderful thing to have, and when you find a mortgage lender that can help you tap into it and use at your discretion, it can open up a world of possibilities that has been stored up for the years you’ve been owning your home.
But you know what they say: with great power comes great responsibility. And home equity is not only a precious resource, it’s a powerful resource. So while tapping into your hard-earned home equity sounds like a great way to fund your plans and dreams, it should be handled with care.
There are some methods to using your home equity that are better than others. Of course, this depends on your particular needs. Ask yourself what’s your purpose for using your equity and you’ll be off to a great start. Because without a clear, defined purpose for the funds, access to cash like that can be tempting to blow on petty expenses.
Homeowners who tapped into their home equity (some as much as 100% of their home value) during the housing bubble learned their lesson the hard way. Without limitations on how much they could access, and without giving careful thought as to what they wanted to use it for, many homeowners found themselves upside-down on their mortgages when the bubble burst and home values plummeted.
Thankfully, limitations have been put in place to keep such disaster from happening again. To help you avoid the pitfalls and decide the best way to access your home equity, we’re going to look at two different methods: home equity line of credit (HELOC) and cash-out refinance.
Your home equity is not only a precious resource, it’s a powerful resource.
A HELOC is a type of loan that allows you to borrow against your home equity and, like a revolving line of credit, you can use that cash how you want as long as you pay it back. (Imagine it like a credit card that’s connected to your home equity rather than your bank account.) A HELOC is another loan in addition to your mortgage, meaning you’d have another monthly payment.
Even though many homeowners benefit from this kind of loan, HELOCs have a number of disadvantages. While their closing costs may be lower than that of other loans, you may face several different types of fees imposed upon you throughout its course, such as an annual fee or an inactivity fee. HELOCs also tend to come with an adjustable interest rate, which can be problematic for a few reasons: no fixed payments, budgeting can be more difficult, and the rate fluctuates with the market (and we know the market can be unpredictable).
HELOCs do offer the option of interest-only payments for a period of time, but when you’re not required to pay down the principal, you run the risk of making payments for a lot longer than you need to. Speaking of interest, the good news with HELOCs is that the interest paid may be tax deductible. However, since the tax bill that passed in 2017, borrowers can only deduct the interest on a HELOC if they used the money to build on or improve the home that secures the loan.
Since the tax bill that passed in 2017, borrowers can only deduct the interest on a HELOC if they used the money to build on or improve the home that secures the loan.
Another drawback? Draw periods. Lenders allow only a specific time period where the borrower can access the money, and they usually enforce a minimum draw requirement—you have to take out their minimum required amount even if it’s more than what you need at the time.
Here’s where the going gets tough: a HELOC is a loan secured by your home. If you’re unable to make payments on your HELOC, you could lose your home. This is one of the many sticky situations some homeowners found themselves in when the housing bubble burst. By essentially using cheaper debt to pay off more expensive debt, they were funding lifestyles they couldn’t afford.
Living outside your means for too long tends to end in disaster. Putting your home on the line makes it even worse. Thus, HELOCs probably aren’t the most stable choice for homeowners who want to spend their home equity. Good thing Cardinal offers a different solution: cash-out refinances.
Living outside your means for too long tends to end in disaster. Putting your home on the line makes it even worse.
CASH-OUT REFINANCE BASICS
A cash-out refinance is when a borrower refinances their mortgage for more than the amount they currently owe and receives the difference in cash. Put another way, it allows you to borrow against your home equity and spend the proceeds like you would cash.
Like a rate/term refinance, a cash-out refinance exchanges your mortgage for a new one with new terms, but with the added bonus of giving you cash on hand. Unlike a HELOC, a cash-out refinance gives you one monthly payment and a fixed amount of money to be used for a specific purpose.
Lenders will limit how much cash you can take out, keeping you from tapping into 100% of your home equity. It’s like putting guardrails around your freedom, and we all know guardrails have been known to save lives.
A cash-out refinance allows you to borrow against your home equity and spend the proceeds like you would cash.
Cash-out refinances can be a great option for borrowers who want to refinance their mortgage and get cash from their equity at the same time. You have the ability to lock in a low fixed rate for the life of the loan, rather than one that’s variable based on the market, giving you fixed, predictable payments that make budgeting simple. Any fees associated with the cost to borrow are paid up front (like when you closed on your home purchase) so there are no surprises down the road. Sure, you can get a HELOC and shop around and compare other lenders’ fees, but have you thought about doing a cash-out refi with Cardinal?
Getting a cash-out refinance should feel a lot like when you first purchased your home. The processes are fairly similar. You have to meet a lot of the same requirements, like credit score, income and asset verification, and debt-to-income ratio. And, if you’re already a Cardinal customer, it’s worth it to stay a Cardinal customer. Since you’re already on file, we’d have to update your information, but the verification process should be much quicker.
If you want to explore your options and find out how much home equity you could tap into, we can help.
This blog post is intended for educational purposes only and is not to be taken as advice. We recommend you consult your financial advisor, legal counsel, and/or tax adviser before you make any financial decisions toward purchasing a home or applying for any kind of mortgage.