The greatest investment I’ve ever made has been buying my first home. After living there for just 1 year, my husband and I decided to purchase another property. We knew we had built up equity (increased the value) in our home, but we weren’t ready to sell. Luckily, there are 2 great ways that banks can help homeowners access the equity in their home: Home Equity Line Of Credit (HELOC) or a Cash Out Refinance.
Comparing HELOC And Cash Out Refinance
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What Is Equity
Equity is the market value of your home minus the remaining value of your loan. For example, let’s say you purchased a home for $100k. Let’s do the math!
Sale Price: $100k
Down Payment: $20k
Original Loan Amount: $80k
Current Loan Amount (due to payments made over the years): $50k
Market Value Of Home (done by appraisal): $150k (your home appreciated over time)
The total equity in your home is: $150k – $50k = $100k
A HELOC is very similar to a credit card in that it is a revolving line of credit. The amount of credit that you qualify for is going to be based on the Loan To Value (LTV) ratio approved by the lender.
Amount You Can Borrow: In the example above, if the lender approves an 80% LTV, you would take 80% of the home value ($150k x .8 = $120k). $120k minus your existing mortgage ($120k – $50k = $70k) means you can borrow up to $70k as a HELOC.
Drawbacks: The rates are typically variable with HELOC, which means the interest rates can rise. Rates are usually higher than a refinance. There may also be fees associated with your HELOC including minimum draw amounts, which may be more than you actually need to borrow.
Cash out Refinance
A Cash out Refinance is a way to essentially get a new mortgage for more than your existing mortgage, allowing access to the extra funds.
Amount You Can Borrow: If your mortgage lender approves a 70% LTV, you would be able to refinance your mortgage for up to $105k ($150k x .7 = $105k). This means you have a brand new mortgage of $105k (rather than the $50k mortgage you previously had) and your new monthly payments will be based off of the new mortgage amount. This new mortgage would cover $50k of the old mortgage, leaving you with $55k in cash ($105k – $50k).
Drawbacks: You borrow everything upfront (compared to HELOC where you may be able to only borrow what you need). This is also a set amount of cash, rather than a revolving line of credit. Once it’s gone, it’s gone. You will also be responsible for closing fees (similar to when you received your mortgage the first time around).
How To Qualify
Free Comparison: For both HELOC and Cash Out Refinance, I recommend checking out Lending Tree’s free resources. They offer comparisons across many lenders, which can vary in rates, fees, and LTV ratios. Play around with both scenarios to determine which option might be the best fit for you.
Credit Score – Rates (and the amount you pay in interest) depend SO MUCH on your credit score. If you feel like your credit score isn’t great, I always recommend improving this before you borrow any money. Here you can find real easy steps to increasing your credit score fast.