Home Equity Loan vs. Cash-Out Refinance
Do you want to convert the equity in your home into cash in your hand? There are a few good options. The tricky part is knowing the difference between the types of loans that are available.
Home Equity in a Nutshell
Home equity loans best suit borrowers who have a substantial amount of equity available to them. You can determine the total amount of equity in your home by subtracting any and all debts secured by your house from the current fair market value of your home. The amount left over is the total equity, or value of ownership, of your house.
Usually, the amount you can borrow is determined by your credit and combined loan-to-value (CLTV) ratio. Your CLTV is your desired home equity loan amount plus your existing mortgage balance, divided by your home’s value. Your CLTV must typically be under 90 percent. When you add a second mortgage to your home, your original mortgage remains unchanged, but you will have two mortgage payments.
Introducing the Cash-Out Refinance Loan Option
The cash-out refinance loan is a loan that refinances your first mortgage into a larger mortgage which allows you to take the difference in cash.
Assuming you have an adequate amount of equity in your home, a cash-out refinance loan enables you to:
- Pay off your existing mortgage.
- Negotiate a new term, rate and repayment schedule for your consolidated loan amount.
- Obtain a new mortgage in the amount of your existing mortgage, plus the additional amount you want to borrow.
- Receive the additional amount in a lump sum.
When you elect to use a cash-out refinance loan to tap your home equity, you enter into a whole new loan agreement. This means the terms, rate and repayment plan for your new mortgage will be different.
Generally, cash-out refinance loans offer up to 30 years for repayment, and you can choose between a fixed or adjustable interest rate. You may even be able to take advantage of potential tax savings depending upon how you are using the “cash-out” portion of your loan (e.g. home improvement). Consult your tax advisor for more information.