Generally when you are purchasing a home, you are buying below the appraised value and you are making a down payment. The good news is this means you have “instant equity” in your home.
For some homeowners, this means may be considering taking cash-out from your home equity in order to pay off credit card bills, purchase a car or pay for college for one of your children. However, it is important understand, this may not be as simple as it sounds.
Cash Out Refinance, Equity Loan Or Second Mortgage
There are three basic ways to access the equity in your home which are common these include:
- Cash Out Refinance – you refinance your current mortgage and you request cash-out for the equity. For example, if your home is worth $200,000 and you have a current mortgage of $100,000 you may be able to access an additional $60,000 to $70,000 in cash depending on your lender’s requirements.
- Home Equity Loan – a home equity loan is typically a line of credit secure by a lien on your property. These loans are typically what are known as “revolving” where you can access the funds over and over again as you make payments. Home equity loans rates are variable and tied to the Prime Rate.
- Second Mortgage – second mortgages are generally fixed rate loans that act much like a first mortgage but with a higher interest rate. They often can go to a higher loan to value than a first mortgage much line a Home Equity Line of Credit; however, they usually come with more fixed costs that a HELOC.
In most cases, lenders require borrowers to own the home for at least six months before they are allowed the option of a cash-out refinance. The exception is if you pay for the home with cash. In this situation many lenders will allow for delayed financing and allow a cash out transaction prior to the standard six month waiting period.
Why Six Months?
Six months may seem subjective but there are some important things to keep in mind. When you applied for your original mortgage, your lender based their decision on the purchase price the market supported at that time.
The lender wants to ensure that the price was not temporarily driven up by a fleeting surge of purchases in a specific area.
While you may already have a substantial amount of equity in your home, lenders are taking an additional risk if you are allowed to “tap into” that equity given the potential for mini price fluctuations and bubbles. The lender also wants to ensure you still have skin in the game. If you purchase a home with the immediate intention of taking cash out to recoup your down payment, you are in essence purchasing the home with zero down. The rate of default increases as the borrower puts less of their own money into the home.