Low Interest Rates, Housing Boom — a Boon for Borrowers

Cash-out refinancings, home equity loans and credit lines can bring cash quickly

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Published December 10, 2020

If you need extra cash for a major purchase, you may be considering getting money from the built-up value of your house. With interest rates so low and housing prices rising in many areas, tapping your home equity can be a way to access extra money without high interest charges.

You have several options, including cash-out refinancing, a home equity loan or a home equity line of credit (HELOC). Here's how each option works, when it might be best, and the downsides.

Cash-out refinancing

With cash-out refinancing, you refinance your mortgage and take out extra money in a lump sum. You can usually borrow up to 80 percent of the home's value, sometimes more, including the mortgage and the cash you take out. Interest rates are so low that many people can benefit from refinancing, even if they already refinanced in the past few years.

For example, suppose your home is worth $200,000 now, and you owe $100,000. You could take out a 30-year mortgage for 80 percent of the home's value — $160,000 — and use the additional $60,000 from the refinance for whatever you like.

The choice can be tempting, given today's interest rates. “The average rate was recently 2.72 percent for a 30-year mortgage, which is fully a point lower than it was a year ago,” says Tendayi Kapfidze, chief economist at LendingTree. “This is the lowest rate on record in history.”

You may also have more home equity than you had a year ago. “There's been a pretty significant increase in home values this year, so you probably have more room to borrow than you had at the beginning of the year,” he says.

Rates for cash-out refinancing can be slightly higher, but they're still lower than home equity loans, says Jon Giles, head of home equity lending at TD Bank. However, the closing costs for any type of refinancing tend to be much higher — generally 2 to 3 percent of the loan value. “You're typically looking at a few thousand dollars in closing costs on a mortgage,” he says. Home equity loans typically have little or no closing costs.

Refinancing costs can be worthwhile if you can reduce your rate and cut your monthly payments by hundreds of dollars. But if you plan to pay back the extra money quickly — or not stay in the house long enough to recoup the closing costs — a home equity loan may work better, Giles says.

If you need more money every month, rather than a lump sum, then you may be able to accomplish that goal just by refinancing without taking out extra cash. “Refinancing your mortgage can free up cash by lowering your monthly payment, or slash thousands in interest by paying off the mortgage earlier,” says Mari Adam, a certified financial planner in Boca Raton, Florida.

You'll have the lowest monthly payments with a new 30-year mortgage, but that could extend your debt long into retirement. Rates are lower on a 15-year mortgage (averaging 2.28 percent, Kapfidze says), but the monthly payments may be difficult to afford if money is tight. You can shorten a 30-year mortgage by adding to your principal when you have more money or paying it off when you sell your house.

Home equity loan or line of credit?

A home equity loan or line of credit is a second loan, in addition to your mortgage. Your loan, plus the balance of your mortgage, can be as much as 80 percent (sometimes 90 percent) of the home's value. The interest rates tend to be higher than they are for cash-out refinancing — currently about 4 to 4.5 percent, says Giles — but the fees are much lower. “Home equities typically don't come with closing costs,” he says. You may have a $99 origination fee and an annual fee of about $50, depending on the lender.

A home equity loan may work better if you don't plan to keep the loan for long enough to make the cost of refinancing worthwhile, or if you already have a low mortgage rate, Giles says.

A home equity loan lets you borrow a lump sum and usually has fixed rates, with a payoff term of 5 to 30 years. A HELOC gives you a borrowing limit and you can take out the money anytime. You generally have up to 10 years to draw the money and up to 20 years to pay it back. “With a home equity line of credit, you have the flexibility of only using as much as you need when you need it,” says Giles. You pay interest only on the amount you withdraw, but rates are variable — usually based on the prime rate (now 3.25 percent) plus about .75 percent, depending on your credit score.

It can be tougher to qualify for a home equity loan or line of credit than cash-out refinancing because if you default, the lender gets paid only after the mortgage lender does, says Kapfidze. Rates can vary based on your credit score and the equity in your home — the lowest home equity loan rates are below 4 percent now, but the average is about 5 percent , he says. You usually need a credit score of 740 or higher to get the best rates, he says.

“Have a clear plan for paying off the new debt,” Adam says. “A home equity loan works best when you are using the funds to improve your home — say, installing a costly new roof — and you have the ability to pay it down over time. It doesn't work well for people who just need short-time access to cash, as it simply digs them deeper into debt."

You could lose your home if you can't afford to keep making payments on any of these loans. If you're in financial trouble, this might be a good time to consider downsizing instead.

"Sometimes, when money is tight, the best solution for many of the consumers we've worked with is to rightsize to a more affordable home with lower maintenance costs,” Adam says. Now can be an especially good time for empty nesters to sell their large suburban homes to families that have been looking to get more space after coronavirus shutdowns.

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