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If the amount you are borrowing is sufficiently large, a cash-out refinance could cost you less in interest and fees than a home equity loan. Bankrate’s editorial team writes on behalf of YOU – the reader. Our goal is to give you the best advice to help you make smart personal finance decisions. We follow strict guidelines to ensure that our editorial content is not influenced by advertisers. Our editorial team receives no direct compensation from advertisers, and our content is thoroughly fact-checked to ensure accuracy.
With each monthly principal payment you make, you own a bit more of your home outright, meaning you gain equity over time. Home equity loan — A home equity loan also allows you to borrow against your home’s equity. You receive a lump sum upfront and repay the loan in fixed monthly payments. Every mortgage comes with closing costs, and those costs can significantly increase the cost of borrowing.
How does a cash-out refinance work?
Instead, it's an entirely new loan that you'd normally repay monthly, along with your existing mortgage payment. If you've already paid off your home, the only monthly payment you'll have to make is on your new home equity loan. The benefit is that your interest rate won't go up and your monthly payments are fixed, too.
If you need the cash to pay off consumer debt, take the steps you need to get your spending under control so you don’t get trapped in an endless cycle of debt reloading. The Consumer Financial Protection Bureau has a number of excellent guides to help determine if a refinance is a good choice for you. A cash-out refinance is a mortgage refinancing option that lets you convert home equity into cash. A new mortgage is taken out for more than your previous mortgage balance, and the difference is paid to you in cash. Cash-out refinance borrowers have the opportunity to deduct the interest on their original loan balance only if they use the equity to make improvements to the property’s value.
Outstanding mortgage balance
Getting cash by using the equity in your home can be an easy way to get funds for emergencies, expenses, and wants. As noted above, the LLPA is waived for loans that meet the student loan cash-out refinance requirements. Cash-out refinances are contingent upon an appraisal by an independent third party. Appraisals can take time, so factor this into your refinancing timeline.
Any payments on the balance remaining from the original loan must be included in the debt-to-income ratio calculation for the refinance transaction. Cash-out refinancing, home equity loans and home equity lines of credit are all methods of capitalizing on your home’s value, but there are important differences. A cash-out refinance replaces your existing mortgage with a higher loan amount, while home equity loans and lines of credit are additional mortgages. When you get a cash-out refinance, you pay off your original mortgage and replace it with a new loan. This means your new loan may take longer to pay off, your monthly payments may be different, or your interest rate may change.
Cash-out refinance loan
Home equity lines of credit often have a draw period of 10 years, meaning you can borrow from the credit line and repay it, as often as you want, within that time frame. After the draw period ends, there’s typically a repayment period of up to 20 years when you cannot borrow from the HELOC and must repay any outstanding balance with interest. As with a cash-out refinance, the amount you can borrow is based on your home’s value. You can pay closing costs out of pocket, or your lender might be willing to cover part of them in exchange for a higher interest rate.
During that first draw phase, which might last 10 years, you can borrow as much against your credit line as you want, up to your limit. You pay back sums you choose, and you can reborrow again, up to that limit, as long as you are in the draw period. Before you commit to paying off a HELOC with a cash-out refinance, explore a couple of alternatives.
She recommends that if you need a lump sum of cash, you consider another way to find the loan amount than borrowing against your primary residence. It’s possible that another type of loan might offer lower interest rates. For example, if you need to pay for your daughter’s college tuition and she needs a car, too, there might be several ways to find the funds instead of getting a new mortgage. Maybe your daughter can apply for a student loan through her college or the government, and you can acquire a low-interest car loan for the car she needs. Owning your home outright provides a valuable equity cushion, and it’s exciting when you no longer shoulder the burden of monthly mortgage payments. The good news, though, is that you don’t have to sell your home to access your equity.
Your home equity is the amount by which the current market value of your home exceeds your current loan amount. But don’t expect to be able to borrow against your entire home’s equity unless you have a Veterans Administration loan. Most lenders cap borrowing secured on your home at 80% of your property value, though the Federal Housing Administration allows 85% on FHA loans. When your home loan is paid off, the redraw facility will close and the money will no longer be accessible.
With a home equity loan, repayment looks much like it does on your first mortgage. You’ll pay the loan back—plus interest—monthly until the entire loan is paid off. Typically, home equity loan terms range from five to 30 years, depending on the lender. Yes, you can still take out a loan against your house—even when it’s fully paid off. Home equity loans, HELOCs, and cash-out refinancing can all be smart options. Home equity line of credit — A HELOC is an adjustable-rate mortgage that allows you to borrow against your home equity with a revolving line of credit, similar to a credit card.
If you are unable to keep up with monthly mortgage payments, your home could be foreclosed on. He says that whether or not your home is paid off, tapping home equity isn't free money, and it's not the same as going to an ATM and withdrawing money from your bank account. "This is borrowing, which must be repaid with interest, and it puts your single largest asset on the line in the event of default," McBride says. "That doesn't make it a bad option, just one to go into with both eyes open." Accessing your extra repayments is usually an easy and simple process as most lenders let you request redraw via internet banking, making a phone call, or visiting a local branch. However, a home equity loan may be somewhat less risky if you aren't also carrying a regular mortgage because you will have less debt overall.
When you do a cash-out refinance on a paid-off home, you don’t have an existing mortgage to pay off. This actually gives you an advantage when it comes to refinancing, because you have more equity in your home. Cash-out refinancing typically requires a credit score of at least 620.
With a limited cash-out refinance, you do not access your home equity. This can be advantageous for those looking to put a little cash in their pockets while refinancing — but not a great fit for those with larger funding needs. The higher your credit score, the lower your refinance interest rate.
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