There are a number of reasons homeowners seek to liquidate some of their home's equity, from bankrolling home improvement projects to paying off higher-interest debt or even funding college tuition.
There are three main avenues to choose from:
When you're considering tapping into your home's equity, it's important to be aware that not all products are created equal. Each option has unique features and considerations.
One option is the VA Cash-Out refinance. This is a new loan that pays off your current mortgage, allowing qualified homeowners to extract cash from their equity.
With a VA Cash-Out refinance, qualified homeowners can typically borrow up to 90 percent of their home's value. Borrowers are subject to market rates because it's a new loan.
Homeowners will need to meet a couple of important VA guidelines if they plan to borrow more than what they owe:
One is a net tangible benefit test that helps ensure the refinance is in the Veteran's best financial interest.
The other is a seasoning guideline. You'll typically need to have made at least six monthly payments on your current loan, and the date of the refinance will usually need to be at least 210 days after the due date for the existing loan's first payment.
Credit and underwriting guidelines for a Cash-Out refinance look similar to those for a VA purchase transaction, including income and asset verification, credit score benchmark and an appraisal.
These refinance loans also come with a funding fee. The fee can be financed into the loan, although homeowners taking out cash will still typically need to meet the 90 percent loan-to-value guideline.
A home equity loan shares some similarities with a cash-out refinance. Both are typically fixed-rate products, and they pay out a lump sum at closing. But a home equity loan is a separate loan, which creates a second lien against your property and won't change the rate or term of your first mortgage.
Home equity loans typically feature fixed rates, making it easier to budget for the long term. Since these are separate from your original mortgage, you won't add extra years to your mortgage term. After you close on a home equity loan, you get a lump sum to spend as you choose
Interest rates tend to be higher on home equity loans compared with mortgage rates. Homeowners whose current mortgage rate is higher than today's market rates might want to consider a refinance rather than or in addition to a home equity loan. Savings from a possible refinance could make a big financial difference over the life of the loan.
Home equity loans often make sense when interest rates today are higher than your first mortgage rate. That being said, home equity loans are subject to market conditions just like mortgage rates, and you may be hard-pressed to find a good deal in a higher-rate environment.
A home equity line of credit (HELOC) isn't a mortgage loan at all. Instead, it's a line of credit extended by a bank or financial institution that uses your home equity as collateral.
While it won't impact your home loan term or rate, it will create a second lien against your property. Unlike home equity loans and cash-out refinances, a HELOC doesn't pay out a lump sum at closing. Instead, you use your line of credit much like a credit card.
Closing costs on a HELOC are usually lower than a refinance product. HELOCs often have two phases – a draw period where you can tap into your home's equity, and a repayment period. Together, these periods typically last anywhere from 15 to 30 years.
HELOC rates are often adjustable, which can make it harder to budget for the payments in the long term. Once the repayment period starts, you can no longer use the line of credit, and your payments (which include principal and interest) are based on your outstanding balance.
Some homeowners use HELOCs to fund longer-term home renovation projects, which can be a good investment assuming that they are increasing your property's value. And in a true financial emergency, a HELOC can be a better option than higher-interest credit accounts.
As you're exploring options for borrowing against your home's equity, ask yourself how you plan to spend the money. If you're hoping to receive a lump sum after closing, a VA Cash-Out refinance might be your best option given today's rate environment.
If today's rates are higher than your current rate, consider a HELOC or home equity loan. The VA Funding Fee can also be a challenge for some Veterans considering a Cash-Out. The bottom line is: Exploring your options with a trusted expert can help.
When you're ready to take the next step, an experienced loan officer can help you understand which product works best for your specific needs.
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