Cash-Out Refinance vs. Home Equity Loan: What’s the Difference?
Compare your financial situation now to when you first took out your mortgage. What’s changed?
Chances are, a lot. Perhaps your interest rates have skyrocketed or your monthly loan payment has become more than you can afford. Refinancing can help you shift your debt to a better place.
Every year, millions of homeowners choose to refinance. Two of the most popular options for obtaining a more desirable interest rate and payment terms are cash-out refinances and home equity loans. Both offer borrowers a lump-sum payout, but each has different terms, fees, and interest rates.
In order to take advantage of these programs, borrowers need a credit score of 680 or above. If your score is lower, prepare to pay higher interest rates.
As you weigh your options, keep your financial situation in mind to determine which, if either, option is right for you.
What Is a Cash-Out Refinance?
Cash-out refinancing requires you to take out an entirely new mortgage. You’ll likely have a new interest rate and a new monthly payment.
According to NerdWallet, “a cash-out refinance replaces your existing mortgage with a new home loan for more than you owe on your house.” The difference between the outstanding balance on your original mortgage and the amount you borrow when refinancing will be paid to you in cash.
While you can spend that money on pretty much anything, Zillow recommends using it to improve your financial situation by paying down debt or renovating your home. Consolidating or eliminating your debt will help improve your overall credit while home improvements can help increase your home’s value. You could also use the lump sum to fund higher education as cash-out refinancing may offer lower interest rates than private education loans.
Compared to home interest loans, the interest rates offered for cash-out refinances are generally lower.
If you bought your home at a time when interest rates were high and you can lock in a lower rate with a cash-out refinance, then this may be the best option for you, according to NerdWallet.
Cash-out refinances are also generally easier to qualify for than home interest loans and offer a longer period to pay back the debt, sometimes even more than the 30 years of a typical mortgage.
As with any financial decision, you’ll want to consider the costs. Cash-out refinancing comes with high closing costs for the loan and often higher monthly payments. After all, you’re taking out a larger mortgage, which means bigger payments and more interest across the life of the loan.
But they can be a savvy option for people looking to borrow a large amount of money without having to deal with multiple loans.
As Alan Moore, CEO of AdvicePay, shared with Bankrate, cash-out refinancing is a “good way to grab equity and keep it all in one loan.”
What Is a Home Equity Loan?
Unlike a cash-out refinance, a home equity loan does not replace your original mortgage. Instead, a home equity loan allows you to borrow money against the equity you’ve accrued in your house, using your home to guarantee the loan.
Your original mortgage, and its interest rate, won’t change. The new home equity loan will be a separate debt subject to current interest rates.
If you bought your home at a point when interest rates were lower than they currently are, then a home equity loan might make more sense than a cash-out refinance, according to NerdWallet.
Because lenders usually pay most or all of the closing costs on home equity loans, they’re also a better option for people who are looking for a smaller lump-sum payout. Why pay thousands of dollars in fees for a cash-out refinance if you only want to borrow an additional $25,000?
Home equity loans are also a smart choice for people who are looking to pay back their new debt quickly. The terms on home equity loans are generally shorter than traditional mortgages and cash-out refinances—often less than 15 years.
“Try to go for the shortest term possible but still have a payment you can afford,” Johnna Camarillo, assistant vice president at Navy Federal Credit Union, told NerdWallet. “Depending on how much you’re borrowing, the difference between a 10- and a 15-year equity loan may only be $50 a month. But the amount of interest you’re going to pay over that extra five years is a lot of money.”
Your Third Option
If you’d like to access the equity built up in your home but don’t like the idea of additional monthly payments or unpredictable interest rates, a home equity investment product could be a good fit for you.
Home equity investment products like Hometap give you access to the equity you’ve built up in your home without interest or monthly payments and have relatively low closing costs.
Before you choose a cash-out refinance, home equity loan, or an equity investment product, take the time to find the smartest way to access cash for your financial situation. Your best solution will depend on how much cash you need, your credit score, and your property, among other factors.
Take our 5-minute quiz to see if a home equity investment is a good fit for you.
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The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, consult with a licensed advisor.
Hometap is made up of a collaborative team of underwriters, investment managers, financial analysts, and—most importantly—homeowners—in the home financing field that understand the challenges that come with owning a home.