What You Need To Know About Home Equity Loans And Cash-Out Refinances In Texas

Nationwide, homeowners had about $16 trillion in home equity as of February 2024, according to ICE Mortgage Technology. The average homeowner has $193,000 in equity that could be withdrawn while still leaving 20% equity in their home. Most mortgage loans require at least 20% equity after the loan closes.

The amount of home equity built up presents an exciting opportunity to use it to help you accomplish home improvement and financial goals. If you reside in the Lone Star State, there are some special rules you should be aware of though.

We’ll go over everything you should know about home equity loans and cash-out refinances in Texas.

Texas Rules For Cash-Out Refinances And Home Equity Loans

To understand what makes Texas different when it comes to a cash-out refinance or home equity loan, it helps to talk about two provisions of the Texas Constitution: 50(a)(6) and 50(f)(2). We’ll break it down in a way that doesn’t require a law degree.

Texas 50(a)(6)

Texas 50(a)(6) is part of a section in the Texas Constitution covering special protections residents have when it comes to their homestead, usually your primary residence. There are several clauses, but there are specific provisions if you’re looking to access your home equity by taking cash out on a primary mortgage or utilizing a home equity loan.

One key guideline we need to cover is the 2% rule. The 2% rule says that a homeowner or their spouse can’t be required to pay more than 2% of the principal on the new loan in closing costs, excluding exceptions for the following:

• Discount points (also referred to as mortgage points) to buy down the interest rate
• Appraisal fees
• Costs for a land survey
• Lender’s title policy
• Title search (as long as the cost is less than that of the lender’s title policy)

The loan has to be agreed to by a homeowner and their spouse. When comparing the value of outstanding loans to the total value of your home the combined loan-to-value ratio (LTV) can’t be more than 80% of the fair market value of the home. This means that you need to leave at least 20% equity in your home after the loan closes.

Both cash-out refinances and home equity loans must be compliant with the provisions under Texas 50(a)(6). This also includes other protections like not allowing penalties for paying off your loan early.

It’s important to note that you can only have one loan with 50(a)(6) provisions, so if you previously did a cash-out refinance, a home equity loan isn’t an option while the terms of the 50(a)(6) persist.

Texas 50(f)(2)

Once you do a Texas 50(a)(6) transaction, every subsequent refinance has to follow requirements for a 50(a)(6). The limitation of this is that it would mean every subsequent transaction would require taking cash out or a home equity loan.

But sometimes you’re just looking to lower your rate or change your term. If that’s the case, you would do a Texas 50(f)(2) refinance to remove the 50(a)(6) provisions.

Another huge benefit of doing a 50(f)(2) loan is that you can qualify for an FHA or VA loan. Because 50(a)(6) loans require conventional financing, it can be difficult to qualify with slightly lower credit scores or debt levels that are a little bit higher. FHA and VA loans enable you to accomplish your goals with more flexible qualification requirements.

In order to refinance under section 50(f)(2), the following conditions must be met:

• Your existing 50(a)(6) loan must be at least a year old when you close on your new loan.
• The home loan has to meet various restrictions regarding the amount of funding provided (that is, you can’t be taking cash out)
• The total amount of the loan can’t be worth more than 80% of the value of the home.
• There’s a 12-day disclosure notice time frame that may impact when you can close.

Cash-Out Refi Vs. Home Equity Loan

So we’ve gone over the regulations, but how do you actually decide between a cash-out refi in a home equity loan. Let’s take a brief look at each option before getting into decision factors.

Cash-Out Refinance

When you do a cash-out refi, you’re taking a new loan with a bigger balance. Importantly, the interest rate and term may change, but you’re making one mortgage payment. The interest rate you see will also typically be lower than a home equity loan because of something called lien position.

When you refinance on your primary mortgage, the lender has first lien position. That means that in the event you default on the loan and lose your home, the lender with your mortgage gets paid first when the property is sold. There’s less risk for the lender, so there’s a lower rate relative to a home equity loan.

Home Equity Loan

With a home equity loan, that’s taking a second mortgage in addition to your primary mortgage. This might make sense for you if your existing interest rate is low enough that it makes more sense from a financial standpoint not to touch the rate on your existing mortgage and to take a second loan. We’ll get into the math in a minute.

Interest rates on a second mortgage are going to be higher than rates on a primary mortgage because the primary mortgage holder gets paid first in the event that you default. This means the rate is higher in order to compensate the lender for taking on more risk. But you could also end up paying less interest overall. Let’s do some math.

Deciding Which Option Is Right For You: Blended Rates

A blended rate helps you take a look at the effective interest rate across both of your payments after you take out a home equity loan. If the effective interest rate is lower than the cash-out refinance rate, you should do the home equity loan in addition to your primary mortgage. If the cash-out refinance rate is lower, that option makes more sense.

This involves an equation. If math isn’t your thing, a Home Loan Expert can help you make sense of all this, but the formula isn’t too bad. The formula is:

The Bottom Line

A Texas 50(a)(6) loan provides specific protections for Texans looking to take cash out or do a home equity loan on their primary residence. One of the big rules involves certain costs not being more than 2% of the loan amount. Additionally, there are disclosure requirements and you can’t be charged a prepayment penalty.

Whether a home equity loan or cash-out refinance makes the most sense for you will depend on some math. You would do a blended rate calculation. A Home Loan Expert can help you with this.

Rocket Mortgage^® offers cash-out refinances and Home Equity Loans in Texas. If you decide this is right for you, you can apply online!

¹ Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00. Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.