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When is a Cash-Out Refinance Better than a HELOC

What you'll learn: Learn about the perks of a cash-out refinance over a HELOC

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May 12, 2023

When is a cash-out refinance better than a HELOC?

Whether you need extra money to make home improvements, consolidate debt, or start an emergency fund, tapping the equity in your home is an easy way to generate cash flow. With fluctuating interest rates, varying loan terms, and repayment periods, it can be tricky to choose the right loan. Here are some instances when opting for a cash-out refinance makes more financial sense than applying for a home equity line of credit (HELOC).

Tapping into your home equity

Home equity is simply the difference between how much your home is currently worth and the amount you still owe on your mortgage. The equity in your home fluctuates over time as you make monthly mortgage payments and when the market shifts.

If the remaining balance on your mortgage is lower than the current value of your home, you may be able to borrow against your home and use the money to fund things like home improvement projects, debt consolidation, and even pay back student loans.

Using the value of your home to begin home improvement projects and pay back debts can be a wise financial choice because equity loan interest rates are usually lower than those of credit cards and personal loans. Home improvement projects may be tax deductible when utilizing the funds to boost home value. Consult a tax adviser for further information regarding the deductibility of interest and charges.

While both a cash-out refinance and a home equity line of credit (HELOC) are two of the most popular loan choices when it comes to accessing the equity in your home, there are some instances when a cash-out refinance may be the better option.

What is a HELOC?

A home equity line of credit (HELOC) is a type of second mortgage that lets you borrow against your home and turns the equity into useable cash. It functions like a credit card allowing access to funds as needed. Interest charges and penalties are not applied to unused funds, giving maximum flexibility to finance large home improvement projects or emergency expenses.

A HELOC is a second mortgage, which means a new loan is added to your property. Now, you will pay two loans at the same time. Keep in mind, there are two different periods for borrowing and repayment on this loan. During the "draw period" your line of credit is available to use and payments only need to be made on the interest owed. After this period ends (typically five to ten years), monthly payments are required on the total amount borrowed.

What is a cash-out refinance?

A cash-out refinance is a type of refinancing that provides you with a larger mortgage in exchange for tapping your equity. This new loan replaces the existing loan, and in exchange you receive a check. The new mortgage will have a higher loan amount at the same term, or extended term. However, it is necessary to reapply and go through the mortgage process again because a cash-out refinance is a primary loan.

Key differences between a cash-out refinance and a HELOC

It is hard to understand the differences between a cash-out refinance and a HELOC. Here is a breakdown of some of the pros and cons of each loan to determine which is best for your financial situation.

Cash-Out Refinance

Primary loan where you must reapply
Loan term may change
Could potentially lower the interest rate depending on market conditions
Monthly payments may increase or decrease
Offers fixed interest rates (if obtaining a fixed-rate loan)
Offers fixed monthly payments (if obtaining a fixed-rate loan)

Home Equity Line of Credit (HELOC)

Adds a second loan
Your current loan stays the same, and you borrow only from the available equity
Offers variable or fluctuating interest rates determined by the current market
Offers interest-only payments during the draw period
When the repayment period begins, you must pay the principal balance of the loan, plus interest

Reasons to opt for a cash-out refinance

While both loans can give you access to the equity in your home, there are some situations when a cash-out refinance is the better option. Here is a list of instances when choosing a cash-out refinance makes the most financial sense.

1. When it lowers your interest rate

When interest rates are low, applying for a cash-out refinance is a good idea. You will receive a check to pay for expenses and lower the interest rate on your mortgage simultaneously. However, when mortgage interest rates rise, HELOCs become more popular as you can tap your equity while the rate and term on your existing loan remain unchanged.

2. When you want to lower your monthly payment

Achieving lower monthly mortgage payments is possible with a cash-out refinance when you extend the repayment term on your new loan. By opting for a 30-year fixed-rate mortgage you will receive cash and lower your monthly payments. Keep in mind, this option accrues more interest over the life of the loan.

3. When you want to pay off your house sooner

Alternatively, a cash-out refinance can be used to switch to a shorter loan term, such as a 15-year fixed-rate mortgage. This adjustment shaves ten years off your repayment schedule and lowers the interest accrued over the life of the loan.

4. When the interest rate is lower than a personal loan or HELOC

Even if you don't plan to adjust your monthly payments or pay off your house sooner, a cash-out refinance may still make sense if it provides a larger loan and a lower interest rate than a personal loan or HELOC. Keep in mind that if moving forward with a cash-out refinance, the entire balance will be subject to that new interest rate. Depending on what you choose to purchase with the extra funds, you might even qualify for tax breaks on closing costs (consult a tax advisor for more information).

When determining which loan is best for you, understanding your financial goals is critical. Consider a cash-out refinance if you want extra cash while paying off your house sooner or lowering your monthly payments and interest rate. Contact your loan originator to help crunch the numbers and find the best loan option.

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Disclosures

¹Except for holidays, rates are updated Monday through Friday at 10:15am EST. The advertised rates and points are subject to change. The information provided is based on 30_YEAR_FIXED_CONFORMING_POINT discount point, which equals percent of the loan amount, and assumes the purpose of the loan is to purchase a property with a 30-year, conforming, fixed-rate loan. Loan amount of $400,000; loan-to-value ratio of 75%; credit score of 760; and DTI of 18% or less. The property is an existing single-family home and will be used as a primary residence. The advertised rates are based on certain assumptions and loan scenarios, and the rate you may receive will depend on your individual circumstances, including your credit history, loan amount, down payment, and our internal credit criteria. Other rates, points, and terms may be available. All loans are subject to credit and property approval.

^*Prime Rate is RV Prime Rate % as of Boat Prime Effective Date . The APR for this Home Equity Line of Credit (HELOC) is based on prime plus a margin and can change monthly. Fixed Rate Advances will be amortized over the Fixed Rate Advance Term, with the payment consisting of principal and interest. Your Annual Percentage Rate for a Fixed Rate Advance will be calculated by adding your Prime Rate, your Margin, and the Additional Fixed Rate Lock-In Margin. Your Annual Percentage Rate for a Fixed Rate Advance shall not exceed 18% and shall be equal to or greater than 1020 ELOC OO CLTV 70 Rate % for primary residences and second homes.

Annual Fee: Notwithstanding the foregoing, an annual fee of $99 will be assessed on each account anniversary.
Home equity lines of credit (HELOC) are variable rate loans and the interest rate is subject to increase after consummation of the loan on monthly basis. Closing costs range between $500 and $8,500 for credit lines of $500,000. Contact a representative for additional details.

Appraisals: PenFed will attempt to establish value via an independent method. If that method is unsuccessful, or the value is not sufficient for the amount requested, an appraisal will be required regardless of CLTV. An appraisal is always required in the following circumstances:

For all loans with a loan amount greater than $400,000.

If an appraisal is required, it must be ordered by PenFed. You will be contacted for authorization and payment prior to ordering. Appraisal fees average $550 to $850 (some run higher).

Closing Cost Credit: PenFed will pay most closing costs associated with a home equity line of credit (HELOC), which includes credit report, flood certification, settlement/closing, property ownership and encumbrances search, recording, property search, and quick close. Member is responsible for any city, county, and/or state taxes if the subject property is located in FL, LA, MD, MN, NY, TN, or VA. If an appraisal is required, the member, who is responsible for the fee whether or not the loan closes, will pay the cost.

Interest may be tax deductible, consult a tax advisor for further information regarding the tax deductibility of interest and charges.

Fixed Rate Advance Lock-In You may lock in an Annual Percentage Rate for Advances during the Advance Period. During your Advance Period, you may choose to have three separate Fixed Rate Advances locked in at any one time, with a maximum of two new Fixed Rate Advances per calendar year. Each Fixed Rate Advance must equal or exceed Ten Thousand Dollars ($10,000.00) and you may not request a Fixed Rate Advance that would cause the amount you owe to exceed your Credit Limit. The only term option for your Fixed Rate Advance is 240 months (“Fixed Rate Advance Term”). However, the term of your Fixed Rate Advance cannot exceed your Repayment Period.

Fixed Rate Advances will be amortized over the Fixed Rate Advance Term with the payment consisting of principal and interest. Your Annual Percentage Rate for a Fixed Rate Advance will be calculated by adding your Prime Rate, your Margin and the Additional Fixed Rate Lock-In Margin. Your Annual Percentage Rate for a Fixed Rate Advance shall not exceed 18% and shall be equal to or greater than 1020 ELOC OO CLTV 70 Rate % for primary residences and second homes and 4.75% for investment properties.

Property Insurance: Property insurance is required.

Multiple PenFed Loans: Multiple PenFed Equity loans and HELOCs are available as long as the member and collateral qualify (except Texas). For Equity loans and HELOCs the total indebtedness cannot exceed $500,000 for all PenFed Equity and HELOCs combined.

PenFed does not lend on:

Mobile homes
Co-ops or time-shares
Properties that are currently listed on the market for sale
Commercial property or property used for commercial purposes, even if a residence is part of the property
Undeveloped property (land only)
Properties with more than 4 units

Properties that are currently under major construction/renovations: Property must be fully livable, with no safety issues. (Examples: no missing rails from stairs/decks, no open walls with wires showing, missing kitchen appliances/counters, missing bath fixtures or unfinished pool).

Additional limitations may apply

Home Equity Line of Credit:

This Account has a Draw Period of 10 years, followed by a repayment period of 20 years.
If only minimum payments are made during the draw period, the loan balance will not decrease.
In Texas, the maximum CLTV available is 80% on owner occupied properties. Additional restrictions apply in Texas, so please ask a representative for details.
In all other states, the maximum CLTV is 85% on owner occupied properties and second homes. Additional restrictions or requirements may apply based on application characteristics.
Property type of Condo has a maximum CLTV of 80%.
The maximum CLTV available is dependent on credit qualification.
Rates vary depending on owner occupancy and CLTV and other loan criteria.

Minimum Loan Amount Requirements in all States:

For an owner occupied property or second home the minimum loan amount is $25,000 and the maximum amount is $500,000 with a CLTV of 85% or less of the fair market value.

Other terms and conditions apply; call 844-918-4307 to speak with a representative for details. All rates and offers are subject to change without notice. To receive advertised product, you must become a member of PenFed.

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When is a Cash-Out Refinance Better than a HELOC