Q: I’m getting divorced and will buy out my ex. The property needs some improvements. Is it better to do a cash-out refinance or a home equity loan or line of credit?
A: Getting cash out of a property can be tricky these days. Unlike a few years ago, lenders remain very leery about letting borrowers leverage the equity out of their homes, regardless of the reason.
If you have plans of doing a cash-out refinance as part of buying out your ex-spouse, you need to know that most mortgage lenders will not let you leverage beyond about 75 percent of the value of the home. Let’s say your home is worth $100,000 and your lender will not let you borrow beyond 75 percent. If you have a 60 percent equity stake in your home, that leaves you with a possible $15,000 cash-out refinance to make your repairs.
If a 75 percent loan-to-value will cover your buyout and provide you with sufficient funds to conduct your home improvements, you'll find fantastic interest rates available to you when you refinance.
Home equity loans and lines
However, there are other considerations when thinking about home equity loans and lines. Most home equity products will let you borrow up to an 80 percent total loan-to-value ratio (TLTV)--this is the combination of your first and second liens as a percentage of the value of the property. As such, you might be able to leverage slightly more money out of the property for improvements by using a home equity loan or line. Home equity loans provide a lump-sum of cash, and you then make payments over a fixed term.
A home equity line of credit works more like a credit card, where you borrow and repay funds over time (and can use the credit line again).
Interest rates for home equity loans are fairly steep, relative to first mortgages. At 6.91 percent, they aren't exactly cheap; home equity lines are 5.19 percent, so they are somewhat less costly.
Which of these might be better? It depends. If you need on-going home improvements, I would argue in favor of the line of credit, while one-time changes might see a home equity loan get the nod.
A 25-year expert observer of the mortgage and consumer debt markets, Keith Gumbinger has been cited in thousands of articles covering a wide range of consumer finance and economic topics in outlets ranging from the Wall Street Journal to the Bottom Line newsletters. He has been a featured guest on national broadcasts for CNN, CNBC, ABC, CBS and NBC television networks and has been heard on NPR and other national and local radio programs. Keith is the primary researcher and writer for HSH.com's MarketTrends newsletter and has authored or co-authored a number of consumer guides on mortgages, home equity, refinancing and more.