Homeowners refinance for any number of reasons. One typical situation is that the family needs a sizable amount of cash to take their next financial steps. The home becomes not only a living space, but an asset to use toward other family needs.
If you’re new to home refinancing, you’re probably wondering how home financing works! There are multiple refinancing options with different target results: lowering mortgage interest, tapping equity, or minimizing monthly payments. If you’re interested in accessing some of your home equity, take a look to learn whether cash-out refinancing or home equity sharing fits your plans best.
How Cash-Out Refinancing Works
A cash-out refinance loan replaces your current mortgage with a new loan that’s higher than the balance you owed before. The idea is you pay off your existing mortgage and have money left over to spend on other financial plans.
You need to have a certain amount of equity to make cash-out refinancing work. Generally, you don’t want to dip below 20% equity in your home. So if you have a home valued at $300,000, and your remaining mortgage balance is $170,000, the numbers could work out like this:
$130,000 equity - $60,000 (i.e., the 20% minimum equity balance you want to keep) = $70,000
So, $70,000 is a good idea of the maximum you’d plan to take from your equity in cash. Whatever amount you take gets added to the new loan in cash-out refinancing, so plan carefully so you only refinance to withdraw the equity you need.
Cash-out refinance benefits
Many of the benefits of cash-out refinancing revolve around getting a portion of your home equity in hand. Having funds to pay off or consolidate debt, make home renovations, or meet other goals can be a positive step for your family. But why go with cash-out refinancing over another approach to using home equity, like home equity sharing?
Depending on your plans, you may be eligible for a tax benefit. You can deduct mortgage interest on the first $750,000 of your home debt if you use home equity loan proceeds to buy, build, or make substantial improvements to your home. This is a change from tax laws prior to 2018, which set a $1.1 million limit and didn’t include the restrictions on how you spend the proceeds.
Cash-out refinancing downsides
Cash-out refinancing may be a good option if you’re planning to put money back into your home (and take advantage of any tax deductions). The main downside is that a poorly handled cash-out refinance can put your home at risk of foreclosure. It’s generally not a wise idea to satisfy unsecured debt, like credit card balances, by putting up your home as collateral. Other downsides include:
- Closing costs: Refinancing comes with closing fees, which usually amount to 2-5% of the loan total. Borrowing $150,000 will cost you around $3,000-$7,500. Ask yourself whether you’ll stay in the home long enough to recoup that value.
- Possible increased interest rate or fees: You agree to a new mortgage, with new terms. Read through your current mortgage details and the cash-out refinance terms thoroughly before you sign.
- Private mortgage insurance costs: If you do need to borrow more than 80% of your home’s value, most lenders require you to pay for private mortgage insurance (PMI). In some cases, you may need to continue to pay for PMI even once you’re back over the 20% equity line.
Cashing out equity can help solve immediate problems. It’s important to work with a financial advisor to spot any strategies you can improve to avoid finding yourself in a difficult financial position again.
How Noah Home Equity Sharing Works
Home equity sharing is a non-loan alternative to options like cash-out refinance. You work with a partnering business that essentially buys a share of your home’s future appreciated value. You get financing up front to represent the company’s share of your home equity. As your home grows in value, or even if the value drops, the amount you’ll need to pay back changes accordingly. So if you get $20,000 in financing and your home appreciates 20% in value, you’ll repay $24,000 to equal the principal plus the appreciated growth.
Benefits of shared equity with Noah
Home equity sharing comes with several advantages that can help you build a financial plan that works for your family. Like cash-out refinancing, you get financing up front to use toward whatever you need. Other home sharing benefits include:
- No monthly payments: Unlike a traditional loan, you don’t need to start repaying the principal right away. Noah doesn’t classify as debt because we’re sharing a portion of your home, not just lending you cash. No monthly payments means you don’t need to rewrite your entire budget. The agreement won’t appear on your credit report, and it won’t count toward your debt-to-income ratio.
- No interest: Loans accrue interest, and sometimes you need to pay a larger proportion of interest before you get to make a big dent in principal. Home equity sharing doesn’t operate on an interest-based model.
- Risks are shared: When it comes to debt, lenders expect every dollar back (plus interest, of course!). If the housing market doesn’t go your way, too bad. You’re still on the hook for the full balance. Home equity sharing agreements work more like a true partnership, where both parties agree to share the wealth or take a loss together. That means if you borrow $20,000 and your home drops 10% in value, you’ll only repay $18,000.
Cons of home equity sharing
You’ve heard before that if something seems too good to be true, it probably is. It’s always smart to consider the potential downsides to any financial agreement before moving forward. Home equity sharing is no exception.
The main drawback to shared equity is that your final payment can end up being higher than the initial financing. As your property value increases, the share you repay the home equity partner goes up, too. If your local housing market booms, it’s possible you could end up repaying more than you would have with another financing option. Presumably, though, if your home value is assessed much higher, the idea is that you’d make more on a sale and keep your share of the extra value, too.
Considering that final repayment on home equity sharing can go down as well as up — meaning the financing company shares in your losses as well as gains — you may decide you’re okay with a possible increase from the initial financing. Talk with a financial advisor for professional advice on your best options.
Should You Get Cash-Out Refinancing or Home Equity Sharing?
How to finance your home is ultimately your decision. You know your situation, your financial habits, and how you feel about the risks and benefits. Your plans to sell your home or not, and how you feel about monthly payments versus repayment by end of term also influence your decision.
A few things to discuss with a financial professional before entering a home financing agreement are payment terms and backup plans. If you go with cash-out refinance without a strong plan in place to meet your new mortgage, you could face foreclosure. Check if the lender or financing company offers any kind of homeowner payment protection program if you fall on hard times and need flexibility on payments.
Consider the financing terms, too. High, long-term costs can cause payment difficulty. If it makes sense to choose an option with a shorter term, that could be a factor in which type of financing is best for you. Many cash-out refinance loans set payments on a 30-year term. Noah’s home equity program sets the term at 10 years.
Home refinancing can be a smart option if you have sound plans for the money you pull from your home equity. Renovating to improve your home’s value or getting out of debt can put your funds to good work. The type of refinancing plan that makes most sense for you depends on your individual situation. Whether you choose cash-out refinancing or home equity sharing, using your equity wisely is the top priority.