Cash Out Refinance Programs
One of the benefits of buying a home is the potential to access cash from your investment. When your home’s value is worth more than what you own on your mortgage, you may be able to take out a loan against the equity. You have two options for cashing in on your home’s equity: cash-out refinance loans and home equity loans. What’s the difference between them, and which is right for you?
Why Would You Want To Borrow Against the Equity in Your Home?
If you need a substantial sum of money, one available option is to borrow against the equity you have in your home. The advantage of doing so is that these loans often have lower interest rates than credit cards and personal loans. Indeed, one of the reasons many get a cash-out or home equity loan is to consolidate debt from higher-interest loans.
What Is a Cash-Out Refinance Loan?
A cash-out refinance loan is a new mortgage based on your current home’s value. With this loan, you borrow more than what you owe on your existing mortgage. The new loan pays off your current one and gives you the remaining cash. Most lenders only allow you to cash in on 85% of the equity.
Your new mortgage is generally paid over a 30-year term. Your monthly payments depend on how much you borrow compared to your original loan amount and the interest rate for your new mortgage. Generally, lenders only allow you to obtain a cash-out refinance loan if you have at least 20% equity in your home.
Where To Get a Cash-Out Refinance Loan
Cash-out refinance loans are available through conventional lenders. Interest rates and credit score requirements vary across financial institutions, so it pays to compare. In addition to traditional cash-out refinance mortgages, two government-backed programs offer this loan type.
Federal Housing Authority Loans
The FHA has several refinancing options; however, not all have a cash-out option. You’ll need to apply for the FHA cash-out refinance loan. To qualify, you must meet the following requirements:
A minimum credit score of 580
A mortgage expense to income ratio of no more than 31%
A fixed expense to income ratio of no more than 43%
An existing loan that is at least six months old
On-time payments for the life of the loan or 12 months, whichever is less
The FHA also requires 20% equity in your home to qualify. Your existing mortgage must be FHA-insured.
Department of Veterans Affairs Loans
The VA backs cash-out refinance loans for active and retired military members who meet the requirements for a Certificate of Eligibility. Unlike FHA refinancing, you don’t need a current VA-backed loan to qualify for this one. You only need to demonstrate eligibility with a COE.
While the VA does not establish minimum credit score requirements, you must meet those the lender sets. You can expect most to have a minimum score in the 580 to 620 range for VA loans. One benefit of cash-out refinance VA mortgages is that you can borrow 100% of the equity available in your house.
What Is a Home Equity Loan?
A home equity loan does not replace your current mortgage. Instead, it gives you a second mortgage based on your home’s equity. Your borrowing capacity depends on your credit score and income, but financial institutions usually cap these loans at 85% of the equity.
With a home equity loan, you continue to make your current mortgage payments. The terms and conditions of that loan do not change. Your new loan serves as a second mortgage, with its own interest rates, terms and conditions. You can usually pay this loan over 30 years.
Where To Get a Home Equity Loan
Home equity loans are available from many financial institutions, including banks and credit unions. Interest rates and eligibility requirements can vary significantly across lenders. It’s a good idea to shop around. Additionally, even those with credit scores as low as 580 may find lenders willing to work with them.
The only federally backed home equity loan is the FHA reverse mortgage. This loan is only available to those 62 and up. To qualify, you must own your home outright or have little left to pay on it. The benefit of this home equity loan is that you don’t have to repay it unless you sell it. Otherwise, your estate pays the loan after you pass.
What Are the Differences?
Aside from the fact that a cash-out loan replaces your existing mortgage and a home equity loan gives you a second mortgage, there are a few other key differences between the two loan types. Those with an FHA or a VA loan don’t have the option to obtain a home equity loan (except for homeowners who meet the requirements for an FHA reverse mortgage).
Cash-out refinance loans provide more choices for those with lower credit scores than home equity loans. Additionally, home equity loans tend to have higher interest rates than cash-out refinance loans, though both typically have lower rates than credit cards and personal loans.
What Are the Similarities?
Both mortgage types allow you to cash in on your home’s equity, but it comes at a risk. In either case, if you can’t make your mortgage payments, you could lose your home in foreclosure.
Cash-out and home equity loans give you quick access to a lump sum of cash. You usually collect the money three days after closing. How you use the money is up to you.
Which Loan Is Right for You?
The right choice for you depends on your current circumstances. If you already have an FHA or VA loan, you may find that a cash-out refinance loan provides more benefits than switching to a conventional home equity loan. On the other hand, if you have a traditional loan with a great interest rate and excellent credit, you may benefit more from a home equity loan.
Where Can You Find More Home Loan Information?
If you have questions about home loans, FHA Insider has the answers. We make it easy for you to find the information you need. Check out our resources for in-depth coverage of mortgage and finance topics.