Homeowners at some point usually think about using their equity in their home to their advantage. Some may use it as a way to finance home improvements or other major purchases, while others use it to pay for college tuition or to consolidate debt. Regardless of your reason, there are several financing options available to get cash back out of your home.
Cash Out Refinance
A cash out refinance loan is when you refinance your current mortgage loan for more than the balance. The extra amount is then given to you as cash back at closing to use as you wish. In this scenario, you would still have just one mortgage payment. Depending on the difference in interest rates between your original mortgage loan and your cash back mortgage refinance loan, it is possible to keep your payments the same while still getting cash back.
Home Equity Loan
A home equity loan is a second mortgage. In this case, your first mortgage would remain as is. You would take on an additional loan to get cash back. A home equity loan can be set up as a loan, where all proceeds are given to you at once, or as a line of credit, where you draw money as you need it.
Deciding on the best route for you is based on your individual situation. The following questions should help you determine the best way to get cash back from your home.
How much equity do you have in your home?
With a cash out refinance, you must usually adhere to set guidelines for loan to value (LTV). Many lenders have a maximum of 80%. This means that your total indebtedness on your home cannot exceed 80% of the value of your home. If the appraised value of your home is $200,000, the maximum you can borrow against it is $160,000. If you have substantial equity in your home, then a cash back mortgage refinance may be the best way to go. Rates on these loans are usually lower than home equity loans because they are the same as a first mortgage.
Some home equity loan programs will allow you to borrow up to 125% of your home's value. With that same $200,000 home, you could have $250,000 in debt. Of course, there are drawbacks to owing more than your home is worth. But the programs are available. If you don't have very much equity in your home or none at all, a home equity loan may be the best route for you.
Can you save on the interest rate by refinancing?
If rates were high when you bought your home, you may be able to save by refinancing. Even a small drop in rates can have a significant impact on your payment and the total interest paid over the life of the loan. If rates are lower, particularly 1 ½ to 2 points lower than your original interest rate, a cash out refinance may be the way to go. In this scenario, you could possibly get the cash back out of your home without even increasing the payment.
However, if rates are higher now than your original mortgage, a home equity loan may be your smartest option. Just as you can save a great deal when interest rates lower even slightly; you can spend a lot more when they rise slightly too. If you have a low rate on your mortgage, it makes sense to leave it at the good rate. Take out the home equity loan to get the cash you need. Even though home equity loan rates are generally higher than mortgage rates, it makes more sense to keep the larger balance at the lower rate.
Do you need one lump sum or will your needs vary?
In a cash out refinance, you will receive the proceeds when you close the loan. If you have one lump sum to pay, this may be the best option. In the case of debt consolidation, it may make sense to combine everything into one loan at once rather than giving yourself yet another line of credit.
On a side note, if you decide to use your equity to consolidate debt, you should have already taken steps to ensure you do not end up in the same situation again. When you consolidate credit cards, the accounts should be cancelled. No matter how disciplined you may be, it's safer to not have the credit limits available if you have had trouble controlling spending in the past.
However, in the case of college tuition, you would not necessarily need the entire amount upfront. In this situation, a home equity line of credit may be the best solution. With this, you can draw the line as needed, whether it's once a year or every semester. The type of loan you choose could depend largely on how you plan to use the money.
Using your home's equity for a cash back mortgage refinance or home equity loan can be a great source of funds. Be sure to use it wisely.