What Is A Home Equity Loan?
Home equity equals the difference between the current market value of your home and the total loan outstanding. Borrowing against your available home equity is called a home equity loan. There are two types of home equity loans:
- Top-up loan: Combines into one account your existing home loan and new loans taken against the same property. Your loan account remains the same, so the loan term, interest rate and repayment cycle do not change. The only change is an increase in the repayment amount.
- Split loan: Divides into two separate accounts your existing home loan and a new loan taken against the same property. As you have a new account for the new loan, you can apply for a different loan term, interest rate and repayment cycle for that loan. Unlike with a top-up loan, you have to make two separate repayments.
You can access all or part of your equity to finance personal and investment property– related borrowings. Generally, you must have equity higher than 20% in your home to make borrowings against it.
- You pay a fixed interest rate. A change in market interest does not affect your repayment amount.
- You can consolidate all your personal and credit-card loans into a home equity loan.
- The interest rate you pay against your home equity is much cheaper than for any non-mortgage loans.
- Your interest payments may be tax-deductible.
- You could use the home equity to purchase an investment property or pay the deposit on an investment property.
- You may face a foreclosure risk. If you are not able to make repayments, the lender may seize the house you used as collateral.
- You pay closing costs if your home equity borrowing is any type other than a personal loan.
- You have to make two mortgage repayments–one for the existing mortgage and the other for your new home equity loan.
- You can get a new mortgage with better loan terms and interest rates.
- You can use the cash-out amount to pay off your high interest credit-card and personal loans.
- Replacing your existing loan with a new one makes the loan term longer (maximum 30 years), reducing your repayment amounts.
- You may face a foreclosure risk if you are unable to make repayments.
- As your loan term stretches out with the new mortgage, so does the period for which you make interest payments.
- Paying off your previous mortgage means closing costs, which can be thousands of dollars; however, if you plan to stay in your home for the long term, you can make up that increased cost in lower repayments.
- If you are using a cash-out refinance for debt consolidation, you risk lengthening the term of the loan more than necessary.
What Is Cash-Out Refinancing?
Cash-out refinancing is taking a loan to replace your first mortgage with a larger mortgage, and taking the difference in cash. You need to have some equity in your property to apply for the cash-out and it’s best if the value of your property has increased since you bought it.
Cash-out refinance example: Your property is worth $180,000, and you owe $100,000 to your lender. You need to leave a maximum of 20% equity–$36,000–in the property as security after refinancing. So, the maximum amount you can refinance your mortgage for is $144,000. After paying the $100,000 for your previous mortgage to the lender, you can keep the remaining $44,000 in cash.
Similarities Between Home Equity Loans and Cash-Out Refinance
The main similarity between cash-out refinance and a home equity loan is that you borrow against the equity in your mortgaged property in both cases. Whether you select cash-out refinancing or a home equity loan, you can walk away with a lump-sum cash payment. You usually cannot borrow 100% of your equity through either option; most lenders require you to leave some equity in your home.
|Loan Type||Provides immediate access to cash via line of credit||Fixed Interest Rate||Fixed Monthly Payments|
|Home Equity Loan||Yes||Mostly yes but there are exceptions||Yes|
What Is The Difference Between A Home Equity Loan And Cash-Out Refinance?
A cash-out refinance pays off your existing mortgage for a new one, while a home equity loan gets you a new loan in addition to your existing mortgage. This is the main difference.
Pros And Cons Of Home Equity Loans
Here are the pros of a home equity loan:
Here are the cons of a home equity loan:
Pros And Cons Of Cash-out Refinance
Here are the pros of a cash-out refinance:
Here are the cons of a cash-out refinance.
When Is A Home Equity Loan Suitable For Me?
If you want to put all your loans into one repayment account, then a home equity loan is the best option for you. As home equity loan rates and mortgage rates are cheaper than most non-mortgage interest rates, your repayments would be more affordable. However, the loan term for mortgages is much longer than for non-mortgage loans, so you will pay more in the long term.
While it is very cheap to release equity up to a Loan-to-Value Ratio (LVR) of 80%, releasing equity to an LVR of 90% LVR requires an LMI premium payment.
We suggest getting your current financial position assessed before deciding on a home equity loan. If you are better off making lower repayments for a longer term than making higher repayments for a shorter term, then a home equity loan is suitable for you.
Use our home equity loan calculator to find out where you stand.
When Is A Cash-Out Refinance Suitable For Me?
Cash-out refinancing is suitable for borrowers looking to use the cash-out sum for paying off personal and credit-card debts. We recommend people make a cash-out only if they can use the money in a disciplined manner.
If you are thinking about spending the cash-out amount on lifestyle expenses and have no concrete plan to afford repayments, then cash-out refinancing is not for you.
Use our cash-out refinance calculator to find out where you stand.
Note: You should refinance only if you plan on staying in the home for at least 18 months, else the closing costs will take up a large portion of your equity. Staying in the home longer than that can make up what you lose on closing costs in lower repayments, assuming you negotiated a better interest rate.
Which One Is Easier To Qualify For?
The major banks are cautious about approving cash-out refinancing when they have little evidence of what you are going to do with the money. This is because a few borrowers use the funds for a purpose other than what they tell the bank, which can result in them defaulting on their loan due to missed repayments. Most lenders restrict the amount of money you can release, to as little as $10,000. But not every lender has such a policy.
Need Help Making A Choice?
If you are still confused about cash-out refinance vs home equity loans, Home Loan Experts can help!
Call us on 1300 889 743 or enquire online today!