After years of making regular mortgage payments, the homeowner feels good to watch their net worth make upward progress. That’s especially true if their house is also gaining value. With a growing amount of equity comes peace of mind, knowing there is the option of tapping into it when they want.
Whether it’s time for a new roof or a need to consolidate debt, homeowners may view a traditional cash-out mortgage refinance as the ideal tool to access the money needed. However, anyone considering a cash-out refi might be unaware of some of the pitfalls, or they may not know about the alternative solutions that might work in their financial favor.
With a cash-out refi, homeowners can borrow against the equity in their home by taking out a new mortgage loan. This new loan includes the original loan balance and the additional amount borrowed against the equity.
“On the surface, a cash-out refi loan appears to be the better option because these tend to have better interest rates compared to other types of loans, especially credit cards and personal loans,” says Wendy Harrington, chief marketing officer at Figure Technologies, a company that offers lending solutions to homeowners. “However, these can end up costing more than homeowners expect, and it’s important to take time to understand what comes with the territory.”
Harrington offers three things all homeowners need to consider before they opt for a cash-out refi loan:
Interest rates are rising: After enjoying historical lows, mortgage interest rates have reached 5%, the highest in eight years, according to the Washington Post. With a cash-out refi, homeowners face trading their lower interest rate for a higher one.
Less convenient than other loan products: The application and approval process for a cashout is anything but efficient, thanks to time-consuming activities like property appraisals and in-person closings. In all, the loan process can take anywhere from 30 to 60 days.
Additional fees: Borrowers often don’t realize that cash-out refis come with closing fees for such things as appraisals, title searches and credit reports, adding another layer of cost to the loan.
A smarter solution that can potentially spare borrowers thousands in interest cost, according to Harrington, is a home equity loan. Instead of starting over with a new mortgage, you’d simply take out a separate loan against the equity in your property. This option lets you keep your mortgage interest rate.
To make things more clear, here’s a comparison of how the two loans could affect a homeowner.
Let’s say they took out a $175,000 mortgage six years ago at 3.625% interest. After making monthly payments of $798, the balance is $153,365. Now they’re looking to do some renovations and pay off some credit card debt, and need to borrow $75,000. With a home valued at $300,000, there’s more than enough equity.
With a cash-out refi loan, they’d “reset”their mortgage balance at $228,365 with an interest rate of, say, 5.75% interest. That brings the monthly payment to $1,333, but in 30 years, when the mortgage is paid off, total interest comes to $287,225 (that’s the interest they paid on their original mortgage and the interest they’ll pay with the refinanced loan).
With a $75,000 home equity loan, they may receive a higher rate, but it applies to a much smaller loan amount. If they secured a home equity loan at 9.0% APR, the monthly payment for the mortgage and equity loan combined would be slightly higher at $1,559. However, the term of the equity loan is 15 years, and the mortgage is still on track to being paid off in 24 years. In all, their total interest payments come to $174,238 (original mortgage plus home equity loan).
Bottom line: In this scenario, a home equity loan comes out as the better financial decision, because not only is the homeowner finished paying six years earlier, they would save $112,987 in interest alone.
Another upside to using solutions other than cash-out refis is that there are now convenient and fast solutions that let borrowers access their equity with ease.
Figure Home Equity Loans PLUS lets borrowers apply for a loan online and get notified of approval in five minutes. Upon approval, funds can be deposited in the bank account of choice in as little as five days. With loan terms of five, seven, 10 and 15 years at a fixed rate, the homeowner can get the cash they need with a payment that fits their budget.
If the homeowner is looking to access the equity in their house to help complete a home improvement project or consolidate bills, taking time to know the options can potentially save them thousands of dollars. Figure has built a calculator to show how much they could save using a Home Equity Loan PLUS instead of a cash-out refi. Calculate potential costs and savings at Figure.com/cashout.
Note that approval in five minutes and funding in five days is based on a typical customer experience for properties located in counties that permit e-signatures and e-recording. Actual funding times may vary.