Which of these 3 options is the best way to tap into your home equity?
Home equity is the cash you have tied up in your house. If you have a lot of equity in your home, you may want to access some of that money for other purposes, such as home renovations or debt repayments.
There are some pros and cons to consider before you decide if you should tap your home equity. But once you've made the choice to borrow against your home, you have another big decision to make: You need to decide how to access the money that's tied up in your home.
There are three main options: Cash-out refinance loans, home equity loans, and home equity lines of credit (HELOCs). The best approach will depend on your specific circumstances.
1. Cash-out refinance loans
Unlike the other two methods of tapping your home equity, a cash-out refinance loan will affect your original mortgage.
When you take a cash-out refinance, you'll apply for an entirely new mortgage loan. The new loan will be large enough to pay off your existing home loan and allow you to take money out of your home.
For example, if you currently owe $300,000 and your home is worth $550,000, you'd have $250,000 in home equity. Let's say you want to take out $50,000. In this scenario, you'd need a cash-out refinance loan for $350,000. That would let you pay off your current loan and walk away with the extra $50,000.
Cash-out refinance loans can be a great option if the rate you can qualify for is lower than the one you pay now. There are numerous benefits to these types of loans. For example:
- You'll have just one home loan to pay
- You'll be able to reduce your borrowing costs
- The interest rate will likely be lower than with a home equity loan or HELOC
- Your mortgage interest will be fully tax deductible if you itemize and your loan value is below $750,000
The downside is that you may have to pay more out-of-pocket closing costs than with a home equity loan or line of credit. You'll also need to make sure you can actually get approved for a lower rate loan. And if you borrow more than 80% of your home's value, you'll probably have to pay for private mortgage insurance to protect the lender.
2. Home equity loan
A home equity loan is another way to access your home's equity. If you go this route, you won't need to change your current mortgage loan at all. You'll just take out a new loan for a set amount. So, if you wanted to take that same $50,000, you'd just apply for a $50,000 home equity loan.
Home equity loans typically have fixed interest rates and you can generally choose a long payoff timeline, so, in that sense, they're similar to your primary mortgage. You'll also need to have equity in your home. Most lenders cap the total amount you can borrow at 90% to 95% of your home's value, even if you have multiple loans.
Home equity loans can be a better option than HELOCs because they come with predictable monthly payments and interest costs. Interest can be tax deductible if you use the money from the loan to buy, build, or substantially improve the home you're taking the equity out of.
3. Home equity line of credit
A HELOC will let you access up to a certain amount of equity in your home. It works a bit like a credit card, as you can borrow up to your credit limit. Then, as you pay your bill, you can continue to borrow and pay back as often as you like. You'll pay interest only on the amount you borrow. Your credit limit depends on how much you can borrow against your property.
This is very different from home equity loans and cash-out refinances, because you don't have to borrow a fixed sum up front. If you don't know exactly when or how much money you'll need, a HELOC could be the right choice. Interest can still be deductible too, if the money is used to buy, build, or substantially improve the home.
The downside is that HELOCs generally come with variable rates, not fixed rates. You won't know how much your repayment costs will be since you can borrow and repay your debt multiple times and your interest rate can change over time.
Which is right for you?
Ultimately, cash-out refinance loans, home equity loans, and HELOCs all serve a purpose. The right one for you depends on several factors:
- Whether you want to borrow a fixed lump sum or have more flexibility
- Whether you want to reduce the rate on your current mortgage
- Whether you want to take out a new loan and leave your existing mortgage alone
Consider each of these three choices carefully so you can make the best decision for you.