Say you took out a $200,000 mortgage to buy a property worth $300,000, and, after many years, you still owe $100,000. Assuming that the property value has not dropped below $300,000, you have also built up at least $200,000 in home equity. If rates have fallen and you are looking to refinance, you could potentially get approved for 100% or more of your home’s value, depending on the underwriting.
Many people wouldn’t necessarily want to take on the future burden of another $200,000 loan, but having equity can help the amount you can receive as cash. Typically, banks are willing to lend out around 75% of a home’s check it out value. For a $300,000 home, this would be around $225,000. You need $100,000 to pay off the remaining principal.
If you decide to only get cash of $50,000, you would refinance with a $150,000 mortgage loan that has a lower rate and new terms. The new mortgage would consist of the $100,000 remaining balance from the original loan plus the desired $50,000 that could be taken out in cash.
In other words, you can assume a new $150,000 mortgage, get $50,000 in cash, and begin a new monthly installment payment schedule for the full amount. That’s the advantage of collateralized loans. The disadvantage is that the new lien on your home applies to both the $100,000 and the $50,000, since it is all combined together in one loan.
Cash-Out Refinance vs. Home Equity Loan
What’s the difference between a cash-out refinance and a home equity loan? Well, with a cash-out refinance, you pay off your current mortgage and enter into a new one. With a home equity loan, you are taking out a second mortgage in addition to your original one, meaning that you now have two liens on your property, which translates to having two separate creditors, each with a possible claim on your home.
Closing costs on a home equity loan are generally less than those for a cash-out refinance. If you need a substantial sum for a specific purpose, home equity credit can be advantageous. However, if you can get a lower interest rate with a cash-out refinance-and if you plan to stay in your home for the long term-then the refinance probably makes more sense. In both cases, make sure of your ability to repay because, otherwise, you could end up losing your home.
The Bottom Line
Getting cash by using your home as collateral through a cash-out refinance, home equity loan, or home equity line of credit (HELOC) can be an easy way to get cash for emergencies, expenses, and wants. These options typically come with lower interest rates than unsecured debt like credit cards or personal loans. However, unlike a credit card or personal loan, you can lose your home if you can’t pay your mortgage, home equity loan, or HELOC. Carefully consider if what you need the cash for is worth the risk of losing your home if you can’t keep up with payments in the future.
The cash-out refinance can be one of the borrower’s best options. It gives the borrower all of the benefits they are looking for from a standard refinancing, including a lower rate and potentially other beneficial modifications. With the cash-out refinance, borrowers also get cash paid out to them that can be used to pay down other high-rate debt or possibly fund a large purchase. This can be particularly beneficial when rates are low, or in times of crisis-such as in 2020?21, in the wake of global lockdowns and quarantines, when lower payments and some extra cash can be very helpful.
