Getting the lowest interest rate possible on your mortgage is key to making it more affordable and paying much less in interest over the life of your loan. Luckily, there are some strategies that you can employ in Washington to snag a lower rate: cash-out refinances and equity loans. This article will go into more detail about these strategies.
Traditionally, the home equity loan has been one of the primary strategies for Washington homeowners wanting to convert some of their equity into cash. But with the recent changes to the tax code, more and more homeowners in Washington State might start looking at the cash-out refinance loan as an alternative.
Back in December, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), which brought several changes to the U.S. tax code. Among other things, it strips some homeowners of their ability to deduct interest paid on home equity loans.
In the past, homeowners in Washington and nationwide were allowed to write off some of the interest paid on their home equity loans, in the form of a tax deduction. But with the passage of the new tax bill, that deduction went away for most homeowners.
But for most other scenarios, tax deductions for the interest paid on home equity loans in Washington have become a thing of the past. For now, anyway.
Which brings us to the cash-out refinance loan. Given the recent changes to the tax code, more and more homeowners in Washington State might begin to consider cash-out refinancing as a way to turn equity into cash. Here’s what you should know about it.
Definition: A cash-out refinance loan occurs when homeowners refinance their existing mortgage loans for a larger amount than what they currently owe, receiving the difference in cash. As with a home equity loan, a cash-out refinance gives the homeowner a way to convert some of the built-up equity into cash. The money received can be used for many purposes, including college tuition and home improvement.
Qualifying for a cash-out refinance or a home equity borrowing option generally depends on the amount of equity a homeowner has and whether they meet the lender’s approval standards. In general, homeowners usually need sufficient equity in the property for either option to work.
A cash-out refinance and a home equity loan both allow homeowners to tap into built-up home equity, but they do so in different ways. A cash-out refinance replaces the existing mortgage with a new loan and provides cash from the difference, while a home equity loan is a separate borrowing option that also lets the homeowner convert equity into cash.
Homeowners often compare these two options based on how each fits their financial goals, existing mortgage situation, and preference for replacing a current loan versus adding a separate equity-based loan.
The tax deduction for interest paid on a primary mortgage loan still exists, up to a general limit of $750,000 for loans taken out after December 15, 2017, and $1,000,000 for pre-December 16, 2017 grandfathered loans. So a homeowner in Washington who uses a cash-out refinance should, in theory, still be able to deduct the interest on the new loan up to the current limit of $750,000 for loans taken out after December 15, 2017, or $1,000,000 for pre-December 16, 2017 grandfathered loans. (With a cash-out refinance, you are essentially replacing your current mortgage loan with a new one.)
Related: Will the tax changes impact home prices?
Despite these changes brought on by the TCJA, home equity loans can still be an effective financing tool for some Washington homeowners. Compared to other strategies, it’s still one of the cheaper ways to borrow money. On average, the interest rates assigned to equity-based loans are generally lower than those applied to credit cards and some other forms of financing. The new law just means that the interest paid on some home equity loans in Washington State will no longer be deductible.
Using home equity can provide access to cash, but it also involves important tradeoffs. Because these options are tied to the home, homeowners should think carefully about how much equity they want to use and how the new debt fits into their overall financial plans.
Before choosing between a cash-out refinance and a home equity loan, it can help to weigh the benefits of receiving funds against the long-term impact on borrowing costs, monthly obligations, and available equity going forward.
Disclaimers: We are mortgage professionals, but not tax policy experts. If you have questions about what is or isn’t deductible in your particular situation, you’ll want to refer them to your CPA or financial advisor.
At Sammamish Mortgage, we have been helping home buyers and homeowners with their mortgage needs since 1992. Our knowledgeable mortgage experts can answer all of your questions and walk you through the mortgage process. We currently lends in all of Washington, Oregon, Idaho, California and Colorado and offers a wide variety of mortgage programs and tools with flexible qualification criteria, including our Diamond Homebuyer Program, Cash Buyer Program, and Bridge Loans. Visit our website to get an instant rate quote or to use our online mortgage calculator. Please reach out to us if you are ready to get pre-approved for a mortgage.
A cash-out refinance replaces an existing mortgage with a new, larger loan and gives the homeowner the difference in cash.
A home equity loan lets a homeowner borrow against the equity in the home, usually as a separate loan from the primary mortgage.
A cash-out refinance replaces the current mortgage, while a home equity loan adds a second loan secured by the home’s equity.
Some homeowners may prefer a cash-out refinance because mortgage interest may be treated differently for tax purposes than interest on certain home equity loans.
It may be deductible if the loan meets current IRS rules and applicable loan limits. Tax treatment depends on how the funds are used and the borrower’s situation.
No. Interest on a home equity loan is not automatically deductible and depends on current tax law and how the borrowed funds are used.
Homeowners often use the funds for home improvements, education costs, debt consolidation, or other major expenses.
Yes. They can still be a practical borrowing option, especially when compared with higher-interest forms of credit.
In many cases, yes. Home equity loans often have lower interest rates than credit cards and some other unsecured borrowing options.
A CPA or qualified tax advisor should be consulted for guidance on whether mortgage or home equity loan interest is deductible in a specific situation.
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