How to Access Home Equity Without a Cash-Out Refinance
If you need a large quantity of money, for home improvements or to consolidate high-interest debt, you may be tempted to consider a cash-out refinance.
A cash-out refinance involves replacing your current mortgage loan with a bigger one. The new loan is sufficient to pay off your existing loan and provide you with cash upon closing.
This refinance loan may be the greatest method to borrow money, but there are better choices than this one.
Before applying, you need to know the following.
Negative Aspects of Cash-Out Refinancing
Every sort of refinancing incurs closing expenses. These charges are typically between 2 and 5 percent of the new loan amount and include legal and origination fees.
The higher the loan, the more the closing fees. Due to the greater loan amounts associated with cash-out refinances, closing costs are often higher.
A cash-out refinancing is substantial since the new loan amount must cover the following:
- A new mortgage loan that pays off your previous mortgage balance and a cash loan backed by your home equity – the difference between your house’s worth and your mortgage obligation.
- In addition to greater closing expenses, cash-out refinancing typically incurs higher interest rates due to the lender’s increased risk of default.
When you need both aspects of a cash-out refinance—the new mortgage and the cash-out loan—it may be wise to pay extra. However, a cash-out refinance may not be the best option if you do not wish to refinance your current mortgage.
How to Access Equity Without Refinancing: Four Methods
A cash-out refinance may not make sense if you currently have a low, fixed-rate mortgage or are close to paying off your current mortgage. Consider a home equity line of credit (HELOC) or a home equity loan as an alternative. These second mortgages allow you to access your home’s equity without refinancing your current mortgage.
Home Equity Credit Line (HELOC)
A home equity line of credit, or HELOC, is a superior method of financing for borrowers who wish to maintain their primary mortgages.
A HELOC is similar to a credit card, except that the loan is secured by the value of your home, allowing the lender to charge a significantly lower interest rate.
You would withdraw from the line of credit as needed and then make monthly payments to settle the remainder. During the draw time of your HELOC, which can run up to ten years, you can borrow and refund cash as necessary.
You would continue to make your existing mortgage payments in addition to the new HELOC’s monthly payment. During the draw period of a HELOC, you only pay interest on the outstanding sum charged to the line (not the entire credit limit).
This loan is useful if you do not require significant cash for a major purchase or project.
A HELOC is typically less expensive than a cash-out refinancing and requires less time to settle due to its reduced closing costs and greater flexibility. There are no use restrictions, and you pay interest only on the amount of credit used.
You can utilize the cash for any reason, including home remodeling, yearly expenses such as college tuition, or to bridge an income gap for your business.
Home Equity Loan
A home equity loan is similar to a personal loan, with the exception that the loan is backed by your house’s equity, which should result in a reduced interest rate.
Like a HELOC, you would continue making regular mortgage payments while adding a second payment for the home equity loan.
A home equity loan, unlike a HELOC, gives out a flat sum upfront and requires fixed monthly payments until the loan total is repaid.
Home equity loans are useful for home improvements and paying off high-interest debt, but there are no restrictions on how the money may be used. For instance, you may purchase a car or pay a down payment on a vacation property.
Refinance Your Current Mortgage and Get a Second One
Even if you require the two components of a cash-out refinance — a new mortgage and an equity-backed cash loan — a cash-out refinance may not be your best option.
Depending on the amount of cash you require, splitting a cash-out refinancing into two distinct loans may be less expensive. You’d:
- Refinance your first mortgage with a loan with a lower interest rate and duration.
- Add another mortgage (HELOC or home equity loan)
If you have an FHA, USDA, or VA loan, you may be able to save even more with a Streamline Refinance loan – a loan that reduces your interest rate or monthly payment without a credit check or house appraisal.
If you have a conventional loan and cannot qualify for a Streamline Refinancing, you may still be able to save money using this technique, as refinance rates are lower for no cash-out loans.
Then, a second loan, such as a HELOC or a home equity loan, might provide the additional funds you require.
Other Cash Sources
Because your property is collateral for mortgage loans, mortgage interest rates are often lower than those for other types of borrowing. They are far cheaper than rates on unsecured credit cards and personal loans.
However, a loan secured by your home equity is still a substantial loan that must be repaid over an extended period. Depending on your unique circumstances, it may be preferable for you to obtain another source of funds.
For instance, if you have auto loans with high-interest rates, consider refinancing them. This will result in cheaper monthly payments, and you may utilize the savings to pay off further debt.
Consider selling your prized collections, expensive stuff, and unused items. If you still have debt after your selling binge, consult a credit counselor about reorganizing it so you can pay it off. Additionally, they can help you build healthier financial habits.
Consider launching a side business with your in-demand abilities. Consider strategies to create revenue in the gig economy, but investigate their expenses and legal requirements beforehand.
Or, you may borrow from relatives, apply for zero-interest balance transfer credit cards, or borrow against your 401(k) using payroll deductions.
These alternatives may lessen your debt burden or provide more favorable conditions than cash-out refinancing.
Considerations Before Cash-Out Refinances
A cash-out refinance an effective instrument. It may be precisely what you need to strengthen your financial foundation moving ahead. If so, the increased loan rate and closing fees will be justified.
However, before applying for this mortgage refinancing option, you should fully comprehend the specifics. Here are some essential considerations.
How Much Money May Be Withdrawn?
Fannie Mae and Freddie Mac establish the guidelines for conventional mortgages. In addition, they restrict the amount of money you may remove from your home’s equity.
Refinancing with cash-out has a maximum loan-to-value ratio of 80%. This would require you to preserve 20% of your home’s present worth. If your home was worth $300,000, the maximum amount of your new loan could be at most $240,000.
This new $240,000 loan would be used to repay your current debt. Then, your cash withdrawal would be made from the remainder. If you owed $230,000 on your previous loan, you were only eligible for a cash refund of $10,000.
Many homeowners lack sufficient equity to pay off their current mortgage, retain 20% equity, and receive cash back.
The VA cash-out refinancing is an exemption to the 80% LTV rule, allowing borrowers to access 100% of their home’s equity. VA loans are only available to veterans, active-duty service members, and certain surviving military spouses.
Do You Fulfill the Requirements for Cash-Out Underwriting?
Refinancing with cash-out is not a source of rapid cash; it is a huge loan secured by your house. As a result, underwriting and qualifying requirements for these loans are more stringent, and closing might take longer than shorter-term financing.
When refinancing with cash-out, conventional lending lenders seek improved credit scores: Homebuyers with FICO ratings as low as 620 can be accepted. For cash-out refinancing, creditors typically want a minimum credit score of 660.
You may avoid fees and more stringent underwriting by selecting government-backed refinancing choices like FHA and VA.
However, these plans have their mortgage insurance upfront premiums. In addition, FHA requires yearly mortgage insurance on all cash-out refinancing loans, whereas conventional cash-out loans do not require PMI. Therefore, they may not make sense if you have substantial home equity.
Are You Comfortable Modifying the Amount and Length of Your Loan?
A cash-out refinance will result in a larger mortgage and likely a higher monthly payment. You will also deplete your home equity, which is an asset similar to your 401(k) or bank account.
This is not a task to be taken lightly.
In addition, obtaining a cash-out refinancing resets the clock on your mortgage. You pay more over time by adding these extra years and interest to a new mortgage.
How Will You Manage Your Funds After You Receive Your Payout?
If debt consolidation is the cause for your cash-out refinance, you should investigate other choices before obtaining this refinance loan.
This is particularly true when combining consumer debt. Using home equity to pay off debt incurred by purchasing items that do not survive the obligation is dangerous.
In addition, some debtors may be tempted to run up their credit cards and incur new debt after paying off their existing debts. Then, they may require a second cash-out refinance to pay off the additional debt, creating a vicious cycle.
Therefore, debt consolidation refinancing is sometimes a terrible choice. It indicates that you must have a thorough strategy before proceeding.
Discuss with a financial counselor how you want to pay off your debts, and have a clear strategy for improved money management in place when the consolidation is complete.
When Is Cash-Out Refinancing the Best Option?
Cash-out refinancing may be the optimal option when:
- You require funds for a long-term investment, such as house improvements or other real estate transactions.
- You have substantial home equity.
- Your current mortgage rate is higher than the lowest rate currently available.
- You have a solid credit history.
- You are eligible for a 100% VA cash-out refinancing as a veteran.
When considering a cash-out refinancing, ask lenders to offer you other possibilities and help you evaluate prices.
What Are the Mortgage Rates Today?
The current mortgage rates for rate-and-term and cash-out refinances are affordable.
To spend as little as feasible for your next loan, you must analyze available alternatives and shop around among competitive mortgage providers.