When you need to access cash from your home or lower your interest rate, you'll encounter two main options: tapping your home equity or refinancing your mortgage. Home equity products (home equity loans and HELOCs) let you borrow against your home's value while keeping your existing mortgage, whereas refinancing replaces your current mortgage with a new one, either to get better terms or to access cash through a cash-out refinance.
For Veterans, the decision involves understanding not just these standard options but also how VA-backed products like VA cash-out refinancing offer unique advantages.
Understanding Home Equity Products
Home equity represents the portion of your home you own. If your home is worth $400,000 and you owe $250,000 on your mortgage, you have $150,000 in equity. Home equity products let you borrow against this equity.
Home Equity Loans
A home equity loan provides a lump sum of cash that you repay over a fixed term, typically 5 to 30 years. You receive all the money at once and make regular monthly payments at a fixed interest rate.
According to the Consumer Financial Protection Bureau, these loans work well when you need a specific amount for a defined purpose like home renovation or debt consolidation.
Your original mortgage stays in place. You now have two separate loans secured by your home, each with its own monthly payment.
Home Equity Lines of Credit (HELOCs)
With a HELOC, you're approved for a credit limit and can borrow as much or as little as you need during the "draw period," which is typically 10 years. You only pay interest on what you borrow.
After the draw period ends, you enter the "repayment period" where you can no longer borrow and must repay the principal and interest. Interest rates on HELOCs are often variable, meaning your payment can change over time.
How Much Can You Borrow?
Most lenders let you borrow up to 80% to 85% of your home's value minus what you owe. Using our earlier example with a $400,000 home and $250,000 mortgage, 80% of your home's value is $320,000. Subtract your existing mortgage and you could potentially access $70,000 through a home equity product.
Understanding Refinancing Options
Refinancing means replacing your current mortgage with a new one. You can refinance to change your loan terms, lower your interest rate, or access cash.
Rate-and-Term Refinancing
This type of refinancing changes your interest rate, loan term, or both, without taking cash out. You might refinance from a 30-year to a 15-year mortgage, or from a higher interest rate to a lower one.
For Veterans with existing VA loans, the VA Interest Rate Reduction Refinance Loan (IRRRL) offers a streamlined process to lower your rate with minimal documentation.
Cash-Out Refinancing
A cash-out refinance replaces your current mortgage with a larger loan, giving you the difference in cash. If you owe $250,000 and your home is worth $400,000, you might refinance for $300,000, pay off your original loan, and receive $50,000 in cash (minus closing costs).
Veterans have access to VA cash-out refinancing, which is significantly more generous than conventional cash-out refinances.
Key Differences Between Home Equity and Refinancing
Interest Rates and Costs
Home equity products typically carry higher interest rates than first mortgages because they're riskier for lenders. If you default, your first mortgage gets paid before your home equity loan. However, they often have lower closing costs, sometimes just a few hundred dollars.
Refinancing gives you a new first mortgage at current market rates but typically involves closing costs of 2% to 5% of the loan amount. VA cash-out refinances often have lower costs than conventional options, and you can roll closing costs into the loan amount.
Monthly Payment Impact
With home equity products, you're adding a second payment to your existing mortgage payment. If your current mortgage is $1,500 and you take out a home equity loan with a $400 monthly payment, your total housing debt becomes $1,900.
Refinancing replaces your current payment with a new one that might be higher or lower depending on the loan amount, interest rate, and term.
Tax Implications
The IRS allows you to deduct interest on home equity debt and refinanced mortgages if the funds are used to buy, build, or substantially improve your home, up to interest on $750,000 of qualified residence loans. If you use the money for other purposes like debt consolidation or buying a car, the interest isn't tax deductible. Consult a tax professional about your specific situation.
When Home Equity Makes More Sense
Your Current Rate is Excellent: If you locked in a 3% mortgage rate a few years ago and current rates are 6.5%, refinancing would nearly double your interest rate. Taking out a home equity product preserves your low first mortgage rate while giving you access to funds.
You Need a Small Amount: If you need $15,000 to $30,000, the closing costs of refinancing might not make sense. A home equity loan or HELOC provides access to smaller amounts more cost-effectively.
You Want Flexibility: If you're not sure exactly how much you'll need or when, a HELOC provides ongoing access to funds. Draw what you need, when you need it, and only pay interest on the amount borrowed.
- You're Planning to Move Soon: If you're selling within a few years, keeping your current mortgage and using a home equity product avoids the upfront costs of refinancing that you won't have time to recoup.
When Refinancing Makes More Sense
Current Rates Are Lower: If market rates have dropped significantly since you got your mortgage, refinancing can lower your monthly payment and total interest cost.
You Need Substantial Cash: For larger amounts like $50,000 or more, cash-out refinancing may make more sense because you're spreading the debt over 15 to 30 years at first-mortgage rates, which are lower than home equity rates.
You Want to Simplify Payments: Rather than juggling two separate loans with different payment dates, terms, and servicers, refinancing consolidates everything into a single payment. This simplification can make budgeting and financial planning easier.
- You Can Access More Equity: VA cash-out refinancing allows you to borrow up to 100% of your home's value in many cases. If you need to access maximum equity, this often exceeds what you can get through home equity products capped at 80% to 85% loan-to-value.
Special Considerations for Veterans
VA Funding Fee
VA loans include a one-time funding fee. For VA cash-out refinancing, the fee is 2.15% for first-time use or 3.3% for subsequent use (for regular military with no down payment). This fee can be financed into the loan amount.
Veterans with service-connected disabilities are exempt from the funding fee. According to the VA, you can claim this exemption by providing documentation of your disability rating. This exemption can save you thousands of dollars.
No PMI on VA Loans
VA loans never require private mortgage insurance, regardless of how much you borrow relative to your home's value. This is a significant advantage over conventional refinancing, where you'd pay PMI if borrowing more than 80% of your home's value. That PMI can cost you hundreds of dollars a month.
Generous Loan-to-Value Ratios
The VA's willingness to back loans up to 100% of your home's value gives Veterans more flexibility to access equity than they'd have with conventional products. This can be especially valuable if you need substantial cash but don't have massive equity built up yet.
Making Your Decision
Choose home equity if your current mortgage rate is significantly lower than today's rates, you need a relatively small amount of cash, you want flexible, ongoing access to funds through a HELOC, or you're planning to sell within a few years.
Choose refinancing if current rates are lower than your existing mortgage rate, you need substantial cash like $50,000 or more, you want to simplify to a single payment, or you can leverage VA loan benefits like high loan-to-value ratios and no PMI.
Moving Forward with Confidence
Both home equity products and refinancing offer viable ways to access your home's equity or improve your loan terms. The right choice depends on your current interest rate, how much cash you need, your plans for the home, and your financial goals.
Veterans have unique advantages through VA-backed loans that can make refinancing particularly attractive, especially the ability to borrow up to 100% of home value without mortgage insurance. However, home equity products still make sense in situations where preserving a low existing rate is the priority. Read more about VA loans and refinancing to explore your options.
FAQs
Can I get a home equity loan or HELOC on my VA loan?
Yes, VA loans don't restrict you from getting home equity products. Any lender can provide a home equity loan or HELOC secured by your home, regardless of whether your first mortgage is a VA loan or another type.
What's better for debt consolidation: home equity or cash-out refinancing?
It depends on your interest rate and how much debt you're consolidating. If your current mortgage rate is low, a home equity loan might be better since you're not giving up that great rate. If rates are lower now than when you got your mortgage, cash-out refinancing could lower your overall borrowing costs while consolidating debt.
How long does it take to close on home equity versus refinancing?
Home equity loans and HELOCs typically close in 2 to 4 weeks. Refinancing usually takes 30 to 45 days, though VA IRRRLs can be faster. If you need cash quickly, home equity products have the advantage.
Can I refinance and get a home equity loan at the same time?
Not simultaneously, but you could refinance first, then apply for a home equity product later once that's settled. However, doing both defeats much of the purpose of either option.
Will I lose my VA loan benefits if I get a home equity loan?
No, taking out a home equity loan doesn't affect your VA entitlement or future ability to use VA loan benefits. Your VA loan remains a VA loan with all its original benefits.
