Cash Out Refinancing vs. Home Equity Loan to Pay Off Debt

09.15.2020 | Category: Homebuying

Do you have debt? If so, you’re not alone. More than 80% of Americans have debt, whether it’s from car payments, credit cards, student loans, mortgages or other sources.

For some, debt can become problematic, stressful and often overwhelming,. Debt is often worsened when a homeowner is burdened with multiple high-interest loans or debt sources that they have to pay each month. The costs can become difficult and feel impossible to manage.

By consolidating high-interest unsecured debt into one low interest mortgage, it can make your ability to repay your debt more manageable. Mutual of Omaha Mortgage offers two financing options on your mortgage to be able to help pay off debt: a cash-out refinance and home equity loan.

Let’s explore what’s involved with each of these loans, as well as their key differences.

Understanding How Cash-Out Refinances Can Help You Pay Down Debt

A cash-out refinance replaces your existing mortgage with a loan for more than what you currently owe, letting you cash-out a portion of the equity that you’ve built within your home. The money that you cash-out on your home refinance can be used to pay high interest debt and consolidate your payments.

A cash-out refinance leverages the equity that you’ve built in your home. Equity is the difference between the value of your home and the amount you still owe on your mortgage loan. As a homeowner there are two ways that you can build equity in your home:

  • Regular Monthly Mortgage Payments: When you make your on-time monthly mortgage payments you are building equity within your home.
  • Increased Home Value: If your home has appreciated in value since you’ve purchased it, you are building equity.

When you complete a cash out refinance, you’ll be getting a new home loan for an amount that’s more than your mortgage balance, but less than or equal to the current value of your home. It’s important to know you can’t pull out all of the equity that you have available in your home. Generally, the amount of cash you can take out is 80% of your home's value.

Depending on the balance of your debt and the amount of equity that you’ve built in your home, refinancing your mortgage can be a good way to restructure your debt at a lower interest rate and lower your monthly payments. By comparison, the average credit card interest rate is 15% or higher, and mortgage rates are currently in the 3-4% range.

When comparing refinancing versus home equity loans, refinancing may be preferable for those who plan on living in the property for an extended period. You can also expect a lower interest rate with refinancing.

Understanding How Home Equity Loans Generates New Liquidity

A home equity loan, sometimes known as a second mortgage, gives you the ability to borrow a fixed amount of money against the value of your home. For some, taking out a home equity loan gives them the ability to be able to pay off high-interest debt, and consolidate debts down to one monthly payment.

With a home equity loan, your home secures the amount of money that you borrow. As a reminder, equity is the difference between what your home could sell for today and what you still owe on your mortgage. Generally, with a home equity loan the amount of money that you can borrow is limited to 85% of the equity in your home (but this can vary by lender).

While home equity loan interest rates tend to be slightly higher than a 30-fixed mortgage interest rate, they still are considerably lower than the average credit card interest rate, which is around 15%. By using a home equity loan to pay off debt the goal is to pay off higher-interest debt with a lower-interest loan.

Similarly to when you originally purchased your home, you’ll be working with a lender like Mutual of Omaha Mortgage to qualify for a home equity loan. As part of the application process, they’ll be reviewing your income, credit, assets, liabilities and the value of your home as part of the qualification process 

It’s important to understand all of the terms of your home equity loan and carefully review how your monthly budget and finances will be impacted. Home equity loans are secured by your home, so if you’re unable to make your monthly payments your home may be used to satisfy the debts.

When comparing home equity loans versus refinancing, home equity loans are preferable for those who are unsure if they’ll want to move within the next few years. It’s also practical for homeowners who like the terms and rates of their first mortgage and don’t want to trade it in for a new one.

How Can Cash Out Refinancing or Home Equity Loans Help You Pay Off Your Debt?

It’s important to remember that refinancing your mortgage or taking out a home equity loan doesn’t eliminate your debt - it restructures it. Debt consolidation is designed to make paying off your debt more affordable on a monthly basis. If you have multiple high-interest credit card or loan payments that you’re only making minimum payments on, it can be virtually impossible to make headway in paying off that debt.

If you have a steady source of income, leveraging the equity in your home might be a viable option. To discuss your debt consolidation plans or refinancing next steps with one of our home loan experts, reach out to us at 1-800-24-RATES.

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