I have refinanced many of my properties over the years and I have also used lines of credit quite a few times. I am a real estate investor who flips houses and buys quite a few rentals so having cash available is important to my business. You can take cash out of properties you own using a refinance or a line of credit, but they are very different loan products. A refinance has a longer-term, could have a fixed rate, but you must use the money at all times. A line of credit has a shorter term, usually has a variable rate, but you can use the money when you need to and not use money when you do not need it. There are pros and cons to each option that I will discuss in detail in this article.
How does a cash-out refinance or line of credit work?
A cash-out refinance is what we are talking about in this article because you are taking cash out of your house. The basic idea is that you have a loan on your house now or you owe it free and clear. A refinance means you get a new loan that pays off the old loan or is put in place with a property owned free and clear. When it is a cash-out refinance the new loan replaces the old loan, pays all of the loan fees, and has money left over that you get to keep. if the new loan is $100,000 and the old loan is $80,000 you might get $15,000 cash back after paying the refinance fees.
A line of credit or a home equity line of credit (HELOC) is a loan as well but usually a shorter-term loan that does not replace the current loan you have on the property. You can still use a line of credit on a house you own free and clear but you can also use a line of credit on top of a mortgage that you may already have. If you have an $80,000 loan and your house is worth $120,000 you may be able to get a $20,000 or $30,000 line of credit against the house and keep the $80,000 loan as well. With the line of credit you can take the money out to use it for whatever you like or if you do not want to use it you can leave the money in the loan and not pay interest on it.
The video below goes over how I used a cash-out refinance on one of my rentals.
Why would you need a line of credit or refinance?
As I mentioned I have a business that uses a lot of cash! We flip houses and have done as many as 26 flips in one year. It takes a lot of money to flip houses even if we use financing to buy the properties. We must pay for the carrying costs, repairs, and interest on the loans. I also buy rental properties which can also take quite a bit of money to buy and stabilize when we are purchasing properties that need work. There are many people who can use the money for their business or for investing. Interest rates on refinances and lines of credit are extremely low right now. While it can add more risk, it is worth it to many to take the equity out of properties they own to use for other investments.
There are people who like to constantly take cash out for other reasons like buying cars or vacations. Is that wrong? I am not here to judge people and tell them what they should do with their money. If they have the money and want to spend it a certain way then go for it. I am a big fan of saving and investing but not everyone lives life the same way. I would warn you to be careful about always relying on house values to increase so you can refinance. Housing prices could go down or your own financial situation could make it difficult to get new loans in the future.
Many other people will use cash-out refinances to pay off other debt or credit cards. I think this is also a good use of the money as it can reduce the monthly expenses but again, if you are constantly racking up more short-term debt and relying on a refinance to bail you out, be careful!
Pros and cons
When you refinance your home with a new mortgage you are usually putting in place a long-term loan with a fixed interest rate, or at least a fixed rate for a specified period of time (Adjustable Rate Mortgage (ARM)). You can refinance with a 10, 15, 20, 25, or even 30-year loan. If you use an ARM you can lock in the interest rate for 3, 5, 7, or 10 years and then that rate can adjust up after that fixed term is over. Usually, an ARM has lower rates than a fixed-rate mortgage, which means the interest rate is the same for the entire length of the loan. When you refinance the property you must use all of the money from the loan. If you get $20,000 cash back after the refinance you get that check or wire. If you want to pay down the loan you can, but you cannot take that money back out again.
When you refinance a personal house you can usually get a new loan up to 80% of the value of the property. When you refinance an investment property you can usually get a loan up to 75% of the value of the property. There may be some small banks or credit unions that will refinance at a higher rate but they are hard to find. If you are refinancing but not taking cash out you should be able to find lenders that will go to 95% of the value of an owner-occupied home. When you refinance it will cost you some money as the origination fees, appraisal, and other costs can be 2 to 3% of the loan amount.
Line of credit
A line of credit is much different than a mortgage. With a line of credit, the length of the loan is usually short with 2,5, or 10-year terms being common. Some lenders may offer 15-year lines of credit on owner-occupied homes. The interest rate is usually variable as well so the rate can go up and down at any time. A big advantage of a line of credit is that you can borrow money from the line, and pay it back, and then borrow it again, unlike the refinance. If you don’t need the money you don’t have to use it, you don’t have to pay interest on it, but it is there when you do need it. A line of credit can often go up to 95% of the value of an owner-occupied home and 75% of the value of an investment property. It can be tough to find lenders that will offer lines of credit on investment properties but they do exist! The line of credit often costs less than a refinance as well since there may not be origination fees. There will be some fees and often the fees for a line of credit on an investment property can be close to the refinance fees, but the fees on an owner-occupied line of credit are usually lower than the fees on an owner-occupied refinance.
Which is better?
There is no one size fits all answer for the best option. It really depends on the person, what they need the money for, how long they need the money, and how much money they need. I have used both a line of credit and cash-out refinance on my personal houses and investment properties.
Line of credit is good for people who:
- Don’t need the money all the time
- Don’t need the money long-term
- Want to maximize the cash they have access to
- Want to minimize the fees needed
A cash-out refinance is good for people who:
- Want the money for long periods of time
- Want a fixed-term interest rate
- Want to replace the mortgage they have now if it has higher rates
I like to use cash-out refinances because I tend to use most of my money all the time. I also like to lock in long-term rates and terms. I know I may be paying more in fees but I am okay with that for the other advantages. What is best for me may not be best for everyone. I would look at your situation and see what options you can find for financing and compare both scenarios to see what is best for you.
Below is an example of a huge cash-out refinance we did!