A Cash Out Refinance and selling one’s home both reap rewards, but is one option better than the other?
What is Home Equity?
Before we discuss the difference between the two sets of benefits each product provides, we need to understand what equity is. Equity is the portion of the home you actually own. With each mortgage payment, a portion goes to the principal. The more principal is paid down, the more house you own. What’s also tricky about equity is the home’s value also plays a large role. If your property value goes up or the mortgage loan balance is paid down, you have more equity. The same goes for the reverse. If your home’s value goes down, you also lose equity.
Let’s think of it in simpler terms. Let’s pretend you own a rare collectible and you only paid $100 for it, but now it’s worth $500. When you first purchased it, you had equity of $100. Because the value of the item went up to $500, your equity has now increased to $500. If you sold the item, you will be getting $500 for it instead of the $100 you originally paid. Again, the same goes for the reverse. If there is no demand for this rare collectible, it is worthless. If the value for it sinks to $5, you have lost all of your equity and then some. You made a bad investment. When this happens with real estate, this means the homeowner is underwater on their mortgage.
How do you build equity?
Building equity can be done via a loan repayment due to the fact that most home loans have equal monthly payments that go toward interest and principal. As your equity increases as you pay down your loan balance. Building equity can also occur with price appreciation where your home gains in value due to the real estate market and your equity grows without you doing anything.
Using your equity for a home equity loan
Due to equity being an asset, you are able to tap into this via partial or lump sum withdrawals. This is usually done via a home equity loan, where you create a second mortgage and use those funds for home improvement, debt consolidation, etc. These loans allow you to access your equity at fairly low interest rates and are easier to qualify for because they are secured by the house. These types of loans can be good alternatives to credit cards or personal loans as you can get an interest rate that is usually much lower. A HELOC or home equity line of credit is a type of loan that allows you to pull out money as you need and only pay the interest as you borrow, similar to that of a credit card. With this loan, you are able to withdraw during the draw period and is typically used for spend over a longer term such as college tuition payments or home remodeling. It is important to keep in mind that when the draw period ends after a certain number of years, you will then enter a repayment period usually featuring variable interest rates.
How do you qualify for a home equity loan?
The biggest qualification for a home equity loan is your credit score. In general, you’ll need a minimum credit score of 620 to qualify for a home equity loan and usually higher than that for a HELOC. Another factor is your LTV or loan-to-value ratio, as you will typically need at least 20% equity in your property to qualify.
Using your Equity to Sell Your Home
Many people buy their first home thinking of it as an investment, hoping to sell it for more than what they paid for it. As time goes on, housing prices go up and so does the value of your home. Picking the time to sell is important, since it can dictate how much profit you can get for the sale of your home. If you sell your current home too early, you lose out on what you could’ve gotten. If you get greedy and wait too long to sell, you could lose out on a lot more.
But what do you do if you don’t have an investment property to sell and want to take advantage of today’s high home values? A cash out refinance is a great way to take advantage of your home’s equity while still living in your home.
Using your equity with a Cash Out Refinance
When people talk about their homes being an investment, they’re usually referring to turning a profit after selling it, or renting it out. For people who only have a primary living space, a cash out refinance can help homeowners take advantage of the peak housing prices without having to sacrifice their home. Since not everyone can afford to own multiple properties, this is beneficial.
If someone decided to sell their home, they would definitely be getting a lot more money back from the sale than when they first purchased the home, but what next? If they were thinking to purchase a home with that money, they would have to pay today’s prices for that home. With all of that profit going towards a different home that’s much more expensive, could you really call that a profit?
There are many reasons homeowners have taken money out of their home. With a cash out refinance, homeowners pay for a home remodel to increase the value of their own home, while also improving their current living conditions. They could even use the money to use as a down payment for an investment property so when housing prices hit their peak again, they can fully take advantage. Homeowners have used the funds from their cash out refinance to pay for their child’s education or to start a business. Whatever the case may be, a cash out refinance is there for homeowners who have equity in their homes to use for whatever they need.