When you own a home, you have a few ways to tap into its value. Once you’re tapped in, you can use that equity to upgrade your home or save some extra money on your mortgage.
Enter your new friends: home equity loan and cash-out refinancing. Both options are highly dependent on the value of your home and how much you still owe on it.
You can snag a value-building home equity loan or an interest-lowering cash-out refinance that will put more money into your pocket and, ultimately, into your home upgrades and maintenance.
You wouldn’t be alone. In the last 6 months, 12.2% of mortgage borrowers have refinanced. That’s more than double the number of borrowers last year.
But which loan type is the right solution for you? Well, that requires a deeper dive.
Home Equity Loan vs. Refinance: The Similarities AND Differences
Home equity loans and cash-out refinancing allow you to keep your built-up home equity in primo condition and provide some other gains:
- Get lump-sum payments: You’ll get cash immediately after closing – not in installments or over time.
- Become your adult piggy bank: Your equity is a source of extra funds. You can use the money for more than home improvements. You can use it for tuition, medical bills, child care, car notes and more.
- Possibly deduct the interest paid: There are scenarios where you can deduct your interest costs from either loan on your annual tax returns.
- Provide interest rate options: Fixed interest rates are the norm, depending on the market environment, but adjustable rates do exist.
Now, when it comes to how a home equity loan or cash-out refinance is set up, that’s when things start to get interesting:
|Type of Financing||What It Is||How It Works|
|Home Equity Loan||A home equity loan is a second-lien mortgage, in which the borrower receives a one-time lump sum cash payout. You’re borrowing money from a new loan based on how much equity you have in your home. Home equity loans are harder to qualify for and come with higher interest rates.||A home equity loan does not replace your existing mortgage. Every month, you will pay your existing mortgage as well as the new second mortgage.|
Example: You apply for a home equity loan of $70,000. Your lender sets your monthly payment at $700. Every month, you’ll pay the lender the $700 and the monthly amount of your original mortgage.
|Cash-Out Refinancing||A cash-out refinancing loan replaces your existing mortgage loan with a new mortgage that’s larger than your current loan balance.||This new loan is used to pay off your original mortgage and any loan and closing costs you choose to pay. You’ll receive the difference between the two loans in cash (in other words: cash-out).|
You’ll get one new monthly payment based on your new loan terms and balance.
Example: You have a mortgage balance of $150,000. You apply for cash-out refinancing of $190,000. When your loan closes, you’ll get a $40,000 payment (the difference between the two balances).
Cash-Out Refinance vs. Home Equity Loan: Count Your Gains (Not Those Gains)
No, we’re not talking about the hard-earned gains you get in the gym. Nice flex, though. 💪
There are benefits and things to consider when you’re thinking about cash-out refinancing versus home equity loans. Right off the bat, the higher interest rate is the biggest distinction of home equity loans.
This costly situation can be attributed to second-mortgage lenders who assume that you’re going to prioritize payments to your first mortgage.
Here’s something else to seriously consider: Your home becomes the collateral for the loan.
To avoid losing your home, you’ll need to keep up your monthly payments.
Home equity loans: Flexibility is just one benefit
Some additional home equity loan perks:
- According to the Federal Trade Commission, you can usually borrow up to 85% of your home’s value or existing equity with the option of fixed payments (payments never change over the life of the loan)
- It can help you avoid paying mortgage insurance on your existing mortgage
- You have the flexibility to keep the existing rate and term of your primary mortgage (you don’t have to touch it if you’re happy with it)
- You may be able to deduct interest on your loan if you plan to use the money for home improvements
Now, what about cash-out refinancing?
Cash-Out refinances: Money in the pocket is always great
Like home equity loans, a cash-out refinance also uses your existing home equity and converts it into cash. Instead of a second mortgage, you get a new primary mortgage with cash back. The more equity you have, the more you can use and convert to cash.
The exact amount you can receive will depend on your lender. Some lenders will limit you to about 80% of the home’s value. It also depends on the type of loan you’re using (a VA loan lets you borrow up to 100% equity) and your credit score (more on that in a sec!). Luckily, it’s relatively easy to qualify for cash-out refinancing.
Here are some more cash-out refinancing benefits:
- 15- to 30-year payback (among other term options)
- You may be able to deduct interest on the loan amount up to $750,000
- You only have one mortgage payment
- It consolidates debt because it’s based on your primary mortgage, so you’re getting the lowest possible mortgage rate for your financial profile
- The ability to pay off high-interest debt, like credit card balances, saves a lot of money, especially when you compare it to paying off balances incrementally over time
How Do I Know If I Can Get A Cash-out Refinance Or Home Equity Loan: It’s All About The Bag (And The Paperwork Inside)
Much like other financing, your ability to qualify for cash-out refinancing or a home equity loan depends first and foremost on your current credit or financial health.
What do your credit reports from the three top credit bureaus – TransUnion®, Equifax® and Experian™– look like? Remember the rush of extra credit boosting your grades in school? Well, higher personal credit points boost your lending options.
How high are we talking? You’ll want your credit score around 740+, as this is what most lenders want to see before approving you for a new mortgage loan.
And there’s more paperwork and more qualifications to consider:
- Income, credit and bank statements: Before getting a home equity loan, you must submit various documents to prove that you qualify
- Closing costs: Both loan types have closing costs like a mortgage, such as attorney’s fees, a title search and document preparation
- Appraisal: This step determines the market value of your property. It will include an application fee for processing the loan, points (one point is equal to 1% of the loan) and an annual maintenance fee that may be waived (check with your lender)
Does It Make Sense To Refinance vs. Get A Home Equity Loan? Make It Make Sense … For You
Good for you if you qualify for a cash-out refinancing or a home equity loan. Question is, which one do you go with?
Here are some starter considerations to help you out:
- Equity: How much of it do you have in your home?
- Your mortgage interest rate: Is it too high for your liking?
- Today’s mortgage market: Are rates higher or lower than your current mortgage rate?
- How much you’d like to borrow: Is adding more value while paying off a loan quickly your top priority? Or are you in the market for a lower, consistent monthly payment?
- Your ideal repayment timeline: How fast can you (or would you) like to pay off your loan?
Depending on how you answered those questions, you know which option scored best for your goals.
Ready for a deeper dive into the decision-making process?
|Get a Home Equity Loan If:||Cash-Out Refinance If:|
|You can pay off the loan quickly. Because these loans have higher interest costs, paying off fast minimizes how much added interest you’ll pay to borrow the money|
You can comfortably handle a second monthly payment
You want to grow your home’s value without affecting your primary mortgage and paying for mortgage insurance
Today’s market interest rates are higher than your existing mortgage’s rate
|You’re on a strict budget and need one consistent monthly mortgage payment with a lower interest rate|
You have plenty of equity and want the lowest rate for extra money toward home improvements, adding to or gaining additional investments and other personal financial goals
Your credit could do with a little love, which might not qualify you for a home equity loan
Market interest rates are lower than the rate on your current mortgage and you want to take advantage of the low rates
And prepare for the plot twist: You can bundle a home equity loan with a cash-out refinance to access even more of your home’s value.
Where Can I Get a Home Equity Loan or Refinance: The Choice Is Yours
By now, you probably know which loan type you want to go with. You might even be considering combining a home equity loan and cash-out refinancing. Naturally, the last question is where you can get either.
You’ve got options: namely banks, online lenders and credit unions.
The advantage of taking out a loan with a bank is that, if it’s your bank, you’re already banking with them for other services, so you’re a safer bet.
The bank may be able to provide you with access to special interest rates or discounts that you might not find anywhere else.
Online lenders have the advantage of meeting you where you are – online.
Usually, all the paperwork is online, too. And that saves time and trees.
Credit unions have a good reputation for handing out personal loans at reasonable rates if you’re a member. It’s worth checking them out as an option.
Mo’ Equity, No Problem
Whether you go the equity loan or cash-out refinancing route, you’ll end up with a higher equity home-sweet-home as your mortgage steadily decreases. Now, that’s really sweet.
Federal Reserve Bank of New York. “SCE HOUSING SURVEY.” Retrieved November 2021 from https://www.newyorkfed.org/microeconomics/sce/housing#/
Federal Trade Commission. “Home Equity Loans and Credit Lines.” Retrieved November 2021 from https://consumer.ftc.gov/articles/home-equity-loans-home-equity-lines-credit