With interest rates at historic lows, you may be wondering if now is a good time to tap the equity in your home for improvement projects, debt consolidation, education funding or other major expenses.
You have two basic options for pulling money out of your home — a Home Equity Line of Credit (HELOC) or a cash-out refinance. Each has pros and cons and an experienced Military Mortgage Advisor with AAFMAA Mortgage Services LLC (AMS) can help you understand which one would be most beneficial for your financial goals.
What’s a HELOC?
A HELOC lets you borrow up to a certain amount, typically 75% to 85% of your home’s value as a revolving line of credit for large expenses, such as a new roof or finishing your basement.
You can take a HELOC out on a home that has a mortgage or is fully paid off. A HELOC works similar to a credit card — you carry a balance from one month to the next and make minimum monthly payments.
A HELOC usually carries a lower interest rate than other types of loans, such as home equity loans, and the interest may be tax deductible (always consult with your tax professional about your particular situation). Unlike home equity loans, however, HELOCs have variable interest rates, meaning your rate could fluctuate up or down based on the fed’s Prime benchmark interest rate.
Other unique characteristics include a “draw period,” typically five to 10 years. During this time, your monthly payments are only for the interest on the loan. After the draw period, many HELOCs have a repayment period of 10 to 20 years when you’ll make regular payments of principal and interest until you pay off the loan. With some HELOCs, you will owe the entire balance when the draw period ends, which you would pay as a lump sum.
While it may be tempting to use the HELOC for a new car or vacation, those spending sprees won’t help you build wealth and could, in fact, hurt you in the long run. Failure to repay the HELOC according to the loan terms will damage your credit score and could result in you losing your home through foreclosure. An even bigger drawback is that if your home value falls, you could end up owing more than your home is worth. This situation, known as being “underwater,” means you won’t be able to refinance your mortgage and it could be difficult to sell your home.
A refinance is when you take out a mortgage that replaces the one you have now, usually to get better terms, such as lowering your interest rate, shortening the loan term, lowering your monthly payments, or some combination of both. A cash-out refinance allows you to get money back plus pay off your existing mortgage with a new mortgage, while leaving some equity in the home. The exact amount depends on the type of loan you’re using.
With a conventional loan, you need to leave 15 – 20% equity in your home. FHA loans allow you to leave just 15% equity, but you’ll have to pay mortgage insurance premiums. Finally, if you’re an eligible active duty servicemember, Veteran or surviving spouse, you may be able to refinance your VA Loan for up to 100% of the appraised value of your property.
The appraised value of your home determines the maximum loan amount and how much cash will be available to you. Many VA lenders cap the maximum loan amount at 90% of the value of the home. However, under new VA guidelines, if the loan meets the certain requirements, you may be able to borrow up to 100% of the appraised value.
Here are some benefits with a cash-out refinance loan:
- Eliminates mortgage insurance (public, private or guaranty)
- Shortens the loan term
- Lowers the interest rate
- Lowers the monthly mortgage payment
- Increases the borrower’s monthly residual income
- Pays for construction (note that AMS also has a construction loan product)
- Moves you from an adjustable-rate to a fixed rate
It’s important to note that just because you can get up to 100% of your home’s value in a cash-out refinance, you aren’t required to borrow the full amount.
We’re Here to Help
If you’re not certain on whether or not it’s the right time to refinance, please contact us today. You will receive an honest and fair comparison of your mortgage options, including a wide range of low-rate and low-cost mortgages designed to meet your needs. Ensuring you obtain the best mortgage possible is our mission. Get your free mortgage assessment today!