As your mortgage matures, you’ll typically gain equity in your home. Home equity is your property’s value minus what you currently owe on your mortgage. For example, let’s say you purchased your home for $300,000, and after a few years of making payments, you’ve lowered what you owe your lender to $200,000. Assuming your home is still worth $300,000, that means you’ve built up $100,000 worth of equity in your home. Cash-out refinances and HELOCs both capitalize on your home’s equity by allowing you to access and use a part of it.
Cash-Out Refinance
A cash-out refinance is a type of mortgage that allows you to take on a larger mortgage in exchange for accessing the equity in your home. Instead of a second mortgage, which means taking out a second loan with its own separate monthly payment, a cash-out transaction means paying off your existing mortgage with a new one. Through this process, you take equity out of your home by refinancing to a higher loan amount (which could increase your monthly payment). You can choose to keep the same term length.
The process of a cash-out refinance is much like the process you went through for your primary mortgage. You choose a lender, apply, provide documentation, and if you get approved, all there is left to do is wait for your check!
Here are the requirements for approval:
- Existing home equity: You need to have equity in your home to capitalize on this type of refinance. Your lender won’t allow you to cash out all of the equity in your home unless you have a Department of Veterans Affairs (VA) loan and qualify for a VA refinance, so before pursuing this route, we recommend taking a careful look at your home’s equity to ensure you can cash out enough to accomplish your goals.
- Credit score: To refinance, you typically need a credit score of 620 or higher.
- DTI ratio: For conventional loans, you’ll need a debt-to-income (DTI) ratio of less than 50%. For FHA and VA loans, your ratio can be higher. Your DTI ratio is your total of your monthly payments divided by your monthly income.
If you aren’t in immediate need of cash but are interested in changing the terms of your current mortgage to get a more favorable rate or extending your loan term to lower your monthly payments, you may be better suited for a rate and term refinance.
Home Equity Line Of Credit
A home equity line of credit (HELOC) is a type of mortgage that allows homeowners to borrow money against the equity they’ve built in their home. A HELOC will take the form of a second mortgage unless you’ve paid off your first mortgage completely. They function similarly to credit cards in that you’re able to access and utilize the funds as you choose – up to a certain limit and within a certain time frame. Rocket Mortgage® does not currently offer HELOCs.
When deciding between a cash-out refi and a HELOC, you may also find yourself considering the differences between a cash-out refinance and a home equity loan. As opposed to home equity loans – which come as a one-time, lump sum of cash – HELOCs offer flexibility because you can borrow against your credit line at any time. This makes HELOCs a popular option for an emergency source of funds.
How A HELOC Works
Since a HELOC will be your second mortgage unless you’ve fully paid off your first, you must remember you’re likely to be adding another loan to your property, which would mean an additional monthly mortgage payment to consider. With HELOCs, there are separate periods for borrowing and repayment, although you’ll make payments on the loan through both periods.
In the first period, also known as the draw period, your line of credit is open and available for use. During this time, you’re able to borrow as needed while making minimum or interest-only payments on what you owe. Once your draw period ends, you’ll no longer have access to the HELOC funds and will be required to start making full monthly payments that cover both the principal balance and interest. This is called the repayment period. The lengths of these periods depend on the type of loan you get, although it’s possible to extend your draw period by refinancing your HELOC.
Here are the requirements for approval:
- Existing home equity: As with a cash-out refinance, you need to have a reasonable amount of equity in your home for a HELOC to be worth your time.
- Credit score: Although the standard credit score needed for a first mortgage is around 620, HELOCs tend to be more difficult to obtain. The requirement for many lenders is 680, although some may require a minimum of 720.
- DTI ratio: You’ll also need a lower DTI ratio, with most HELOC lenders looking for 43% or lower.
