When homeowners need money for home renovations, debt consolidation, or other expenses, two popular options are cash-out refinances and home equity loans. Both options can allow you to access your home's equity, but which one is the best choice for you? In this article, we'll dive into the differences between cash-out refinances and home equity loans, their pros and cons, and how to decide which option is right for you.
A cash-out refinance replaces your existing mortgage with a new one that's for a larger amount than what you currently owe. The difference between your old mortgage and the new one is paid out to you in cash, which you can use however you need. With a cash-out refinance, you'll typically receive a lower interest rate than you would with a home equity loan because it's a first mortgage, which means the lender has a higher claim to your property. Plus, you'll only have one mortgage payment each month instead of two.
However, there is a downside to cash-out refinances. You'll have to pay closing costs, which can be several thousand dollars. Also, you'll be taking on a larger mortgage balance, which means it will take you longer to pay off your home. Finally, if you sell your home soon, you may not recoup your closing costs, which can leave you in a worse financial position than before.
A home equity loan is a second mortgage that allows you to borrow against the equity you've built up in your home. You'll receive a lump sum of money that you can use for whatever you want, and you'll have a fixed interest rate and monthly payment for the life of the loan. Home equity loans can be a good option if you need a large sum of money upfront and want the security of a fixed interest rate and payment.
However, home equity loans also have some downsides. Your interest rate will be higher than with a cash-out refinance because it's a second mortgage. You'll also have to make an additional monthly payment, which can make your monthly expenses more difficult to manage. Finally, if you fall behind on your payments, you risk losing your home to foreclosure.
So, how do you decide which option is right for you? Here are some factors to consider:
How much money do you need? If you only need a small amount of money, a home equity loan may be a better option because it will have lower closing costs than a cash-out refinance. If you need a larger sum of money, a cash-out refinance may be the better option because you can borrow more.
What's your credit score? If you have a high credit score, you may qualify for a lower interest rate on a cash-out refinance. If your credit score is lower, a home equity loan may be the better option because you'll have a fixed interest rate regardless of your credit score.
What's your income and debt-to-income ratio? If you have a stable income and low debt-to-income ratio, a cash-out refinance may be the better option because you'll qualify for a lower interest rate and larger loan amount. If you have a high debt-to-income ratio, a home equity loan may be the better option because you'll have a fixed monthly payment and won't be taking on additional debt.
How long do you plan on staying in your home? If you plan on selling your home soon, a cash-out refinance may not be the best option because you'll have to pay closing costs and you may not recoup them if you sell your home soon. In that case, a home equity loan may be the better option because it has lower closing costs and you'll have a fixed payment for the life of the loan.
Cash-out refinances and home equity loans are both good options for homeowners who need money for home renovations, debt consolidation, or other expenses. Each option has its pros and cons, so it's important to weigh them carefully and decide which one is right for your specific situation. Consider factors such as how much money you need, your credit score, your income and debt-to-income ratio, and how long you plan on staying in your home. With careful consideration, you can choose the option that will help you achieve your financial goals while minimizing your risks and costs.