If you need to borrow money for home renovations but you don’t want to tap your assets, a cash-out refinancing of your home could be a good move. Generally, when expenses such as a new roof or backyard renovation present themselves, cash-out refinancing might make sense, but there are costs associated with going this route, so it’s important to consider all of your options carefully.
When you cash-finance an expense you forgo the future benefits of that money working for you and compounding overtime, but cash-out financing allows you to keep that money at work. There are two ways most borrowers accomplish cash-out refinancing. Here’s a quick overview of the pros and cons associated with each.
1. Home Equity Lines of Credit
A home equity line of credit, or HELOC, is a good, low-cost option to access your home equity. Most cost a few hundred dollars at most to obtain, don’t require a full appraisal report, and offer the flexibility of accessing funds easily. The home equity line of credit is an adjustable-rate loan tied to the prime rate. Typically, rates on such loans are currently under 4.5% with excellent credit.
However, with the Federal Reserve poised to raise interest rates in the near future, it is reasonable to assume having a higher payment at a higher rate over time. In short, a home equity line of credit will allow you to access your home equity, but generally should be paid off in full within one or two years. If you don’t have the financial capacity to pay off the loan in that time, a fixed-rate new mortgage might be a more advantageous route with greater predictability.
2. New Mortgage
For the more traditional cash-out refinancing option, fees can average in the $3,000 area depending on your desired loan size. Typically, most banks will let you cash-out refinance up to 75% loan-to-value with varying credit scores. In other words, the credit capacity for cash-out refinancing your home is more flexible if there are credit or qualifying issues that could otherwise make a HELOC sticky.
Refinancing with a 30-year fixed rate means you’re paying the interest expenses over a 360-month period. A sound bet would be to make principal prepayments if you have the financial ability. Making extra prepayments – even just a 13th payment once per year – can have a dramatic effect on your payment time frame and interest expenses. The cost of predictability is the fixed-rate loan for your cash-out refinance. While a 30-year fixed-rate mortgage costs more, it also means the payment remains unchanged over time.
If you are undecided, talk to a mortgage lender (Full disclosure: I am one). A good one can walk you through the in-depth pros and cons of each option, arming you with the information necessary to make the most informed choice with your finances.
Remember, checking your credit before taking out a new mortgage or HELOC can help ensure you get the best financing options possible. You can start by checking your credit scores. You can get two free credit scores, updated every 30 days, at Credit.com. to see where you stand. It’s also a good idea to check your credit reports for errors that you’ll need to dispute, or problem areas that you need to work on in order to improve your scores.