A home equity line of credit and a cash-out refinance are two ways to turn your home’s current value into funds for other goals, like paying for home improvements or consolidating debt.
Home equity lines of credit are often mentioned in the same context as cash-out refinances. While both allow you to tap into your home’s equity — the portion of your home you own — the two financing options aren’t exactly the same and have different benefits.
Are you looking for a way to leverage your growing home equity? Let’s explore how these two methods are the same and how they differ.
Differences in Cash-Out Refinance vs. Home Equity
With a home equity line of credit, you get the cash by borrowing against your home equity, which is the difference between the current value of your home and the amount left to pay on your mortgage.
If you already have a mortgage, a home equity line of credit will be a second payment to make. A cash-out refinance replaces your current mortgage with a new one complete with its own term, interest rate, and monthly payment.
Cash-out refinances offer a lump sum. Home equity lines of credit let you pull out money as needed. Most home equity lines of credit also come with adjustable interest rates, so be prepared for your monthly payment to change over time.
Another key difference is how these loans are repaid. A cash-out refinance replaces your existing mortgage loan (meaning you’ll continue to make just one monthly payment), but a home equity line of credit adds a second monthly payment in addition to your existing mortgage.
Also, home equity lines of credit take just about two to three weeks to complete, while a cash-out refinance can take months.
Cash-Out Refinance Requirements
Your rate is based on the loan-to-value (LTV) ratio along with your credit score, and the value of the loan. The value of your home will usually need to be appraised to accurately determine its value.
The recommended DTI varies across lenders. Some follow the guidelines of the Consumer Financial Protection Bureau, which suggests that borrowers keep their debt-to-income ratio under 43%. The lower your debt-to-income ratio, the easier it can be to qualify. Additionally, a typical minimum credit score is at least 620.
The Costs of Refinancing
A cash-out refinance gives you the flexibility to change the terms of your original loan, saving you money in the long run. In other words, if you qualify for a lower interest rate or shorten the loan term, you could reduce the amount of interest you pay over the life of the loan.
Also, repaying a cash-out loan requires a single monthly payment. Depending on your situation, this could be easier to budget for over possibly having two monthly payments when using a home equity line of credit.
Home Equity Requirements
To qualify for a home equity line of credit, you will need to have at least 15% – 20% equity built up in your home. Usually, lenders will require an independent appraisal to assess the equity value in the home.
Keep in mind your debt-to-income (DTI) ratio should be somewhere under 43%. Your DTI ratio is determined by calculating your monthly debt obligations by your pre-tax (gross) income. It’s important not to overextend yourself and borrow more than you are comfortable repaying. Last, you need a qualifying credit score alongside a strong history of paying your bills on time.
Related: Requirements for a Home Equity Line of Credit (HELOC)
The Costs of a Home Equity Line of Credit
There are different home equity line of credit options available to you at UCCU including low variable rates, fixed rates, and flexible pay. Each offers its own terms, advantages and comes with no origination fees nor closing costs. Overall, these lines of credit have lower closing costs than other personal loans. They can also be a great source of emergency funds.
Cash-Out Refinance vs. Home Equity: Which Is Better for You?
When you’re considering a cash-out refinance vs. home equity line of credit, the best option depends on your finances. You want to consider your current mortgage rate, the amount of home equity you have, and how you want to use the money.
A home equity line of credit is best if you’re not sure how much you need, you want access to cash for an extended period of time, or you’re not interested in replacing your current mortgage loan’s rate or terms.
If you have a set amount of costs you need to cover, you want to consolidate debt, or you could benefit from replacing your existing mortgage loan with a new one, a cash-out refinance is the better option.
Want to learn more about home equity lines of credit? At UCCU, our team is here to walk you through your options and answer any questions you have to feel confident in your decision.
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