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Difference between a cash-out refinance loan and a home equity line of credit
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What is the difference between a cash-out refinance and a home equity line of credit?
If you need cash to pay an expense, make a repair or simply meet a financial goal, look no further than the value in your home. There are several options, but two common approaches are either a cash out refinance loan or a home equity line of credit (HELOC). Let’s look at the differences so you can decide the right solution for you.
Cash Out Refinance Loan
Your home has value, which can be beneficial if you need some cash to meet a financial goal. A cash-out refinance loan refinances your current loan with a new, larger loan, allowing you to take the difference in cash. The amount of the new loan is based on the equity in your home plus your creditworthiness as determined by your lender. A cash-out refinance provides you with cash and a new loan payment with a fixed interest rate over a fixed length of time.
Home Equity Line of Credit
A HELOC — also known as a home equity line of credit — allows you to borrow against the equity you’ve already built up in your home. A HELOC is similar to a credit card, letting you access money up to a certain amount. Payments include the amount borrowed plus interest, which is established by the lender. This approach provides flexibility around the amount borrowed, frequency of borrowing and when payments are made. But just like a credit card, it’s important to be diligent about making regular payments or your credit score could be impacted.
Other Options to Access the Home Equity
A home equity loan is another option that allows the owner to borrow money against the equity in the home. Also known as a second mortgage, the value of the new loan is dispersed in a lump sum. A home equity loan offers a fixed interest rate and monthly payment amounts, but you still must pay your original mortgage as well.
It’s easy to confuse a home equity loan and a home equity line of credit. While both use your home as collateral, there are differences in the interest rates and payment requirements. A home equity loan has a fixed payment schedule with a fixed interest rate. A HELOC has a variable interest rate with variable payment amounts.
Costs of Accessing Home Equity
There are some costs associated with accessing cash from your home equity. For a cash-out refinance loan, you are creating a new loan with associated closing costs. While these costs vary, expect to pay 2% to 6% of the loan amount in fees.
The cost for a HELOC may be a bit lower – averaging 2% to 5% of the loan amount – the lender might make up the difference through the variable interest rate charged on the payments.
Pros and Cons of cash-out refinance and Home Equity Line of Credit
Before taking out any type of loan involving your home, make sure you look at the pros and cons.
- What are the costs associated with the loan?
- What are the payment requirements?
- What is the interest rate, and is it fixed or variable?
- How is the money dispersed?
- How much money can be accessed?
- How will the loan impact credit score?
- How will a missed payment impact credit score ?
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We are here to answer your questions!
Q. What are the disadvantages of a cash-out refinance loan?
Because a cash-out refinance loan essentially creates a new loan, there are associated up-front closing costs. The interest rate on that new loan may not be a favorable as the previous loan. Failure to make the required payments can result in foreclosure.
Q. What are the disadvantages of a home equity line of credit?
There are several risks associated with a HELOC. Failing to make timely payments could result in your lending reducing or freezing your credit line – or taking possession of your home! The interest rate on a HELOC can also be variable, making it susceptible to changes in market rates.
Q: Can I do a cash-out refinance loan and a home equity line of credit?
It is unlikely that you can do both, but you should consult with your lender.
Q: Is it better to do a cash-out refinance loan or a HELOC?
A: The decision should be based on the equity in your home, your current loan amount, the amount of money needed, and how you plan to use those funds.
Q: Is a cash-out refinance loan the same as a HELOC?
No. A HELOC is a line of credit, similar to a credit card, that allows you to borrow cash against the equity in your home. A cash-out refinance loan replaces your current loan with a new loan at a higher amount, with the difference made available in cash.