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Getting cash from the equity in your home can be a smart financial move, whether you want to fund home improvements, consolidate debt, pay tuition or handle other expenses. But how you tap that equity makes a big difference. The two main options are a cash-out refinance and a home equity loan.
I compared the pros and cons of each to help you determine which is the better fit for your needs. I also look at key factors like costs, interest rates and loan terms. A loan calculator can help you estimate monthly payments
How a Cash-Out Refinance Works
With a cash-out refinance, you get a new mortgage to replace your existing home loan. The new loan amount is higher than what you currently owe, so after closing costs and paying off the old mortgage, you get the difference in cash
For example, let’s say your home is worth $300,000 and your current mortgage balance is $150,000 You decide to cash-out refinance with a new loan amount of $210,000 After costs, you’d get roughly $60,000 in cash.
The benefits of a cash-out refinance include:
- Typically lower interest rates than home equity loans
- Opportunity to consolidate debts into a lower rate
- Potentially deduct mortgage interest on taxes
Downsides are the costs, paperwork and time needed to close the new mortgage. You also start over with a new 30-year loan term.
How a Home Equity Loan Works
A home equity loan is a second mortgage that taps your home’s equity while leaving your first mortgage intact. The home equity loan has its own interest rate and monthly payments.
With a home equity loan, you get a lump sum when the loan closes and repay it over a fixed term, usually 5 to 20 years. Interest rates are higher than first mortgages but lower than other loan types.
Benefits of a home equity loan:
- Lower costs than refinancing
- Maintain the term and rate on your first mortgage
- Often faster to close than refinancing
The downside is the higher interest rate compared to a first mortgage from refinancing. You also have the burden of an additional monthly payment.
Key Factors to Compare
Here are some key factors to weigh when deciding between a cash-out refinance and home equity loan:
Interest rates – Cash-out refinances typically have lower rates, often similar to rates for a first mortgage. Home equity loans have higher rates but lower than other loan types.
Closing costs – A cash-out refinance has higher closing costs, often between 2% to 5% of the loan amount. Home equity loans have lower fees, sometimes none.
Monthly payments – A cash-out refi replaces your current mortgage payment. A home equity loan is an extra payment.
Payoff time – Cash-out refis have a new 30-year term. Home equity loans have set repayment terms of 5-20 years.
Tax benefits – Mortgage interest from a cash-out refi may be tax deductible. Home equity loan interest usually isn’t deductible.
How Much Cash Can You Get?
The amount of cash you can take out depends on factors like:
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Loan-to-value (LTV) ratio – The percentage of your home’s value you can borrow. Often 80% LTV for a refi, 75-85% for a home equity loan.
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Home equity – Lenders require you maintain 20-25% equity in the home. More equity means more cash available.
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Credit score and debt-to-income ratio – Key factors lenders review that affect loan eligibility and terms.
Use an online calculator to estimate how much cash you may get based on your specific financial situation.
When a Cash-Out Refi Makes Sense
Some situations where a cash-out refinance could be the better option:
- You want to consolidate debts into a lower rate
- You need funds for a major remodel or addition
- You have significant equity to tap at lower rates
- You are able to deduct mortgage interest
Just keep in mind closing costs are high, so it makes more sense if you’re taking out a larger amount of cash.
When a Home Equity Loan is Better
Here are some cases where a home equity loan may be the better call:
- You need a smaller amount of cash fast
- You have an existing low mortgage rate you want to keep
- You don’t want the hassle of refinancing
- You can’t deduct mortgage interest for tax benefits
Since closing costs are low or none, a home equity loan works well if you need a smaller amount of cash.
Alternatives to Consider
Besides a cash-out refinance and home equity loan, also look at:
Home equity line of credit (HELOC) – Revolving credit line you can tap as needed. Interest rates are variable.
Personal loan – Unsecured loan for debt consolidation, renovations, etc. Quick funding but higher rates.
Using home value for retirement – Options like reverse mortgages let you turn equity into income.
Questions to Ask Yourself
Before deciding, ask yourself:
- How much cash do I need? What’s the purpose?
- What are the rates and terms available to me?
- What are the costs involved with each option?
- How might my tax situation be impacted?
- What are my other debt obligations?
- How long do I plan to stay in this home?
Doing a side-by-side comparison and using loan calculators can help determine if a cash-out refinance or home equity loan better fits your financial situation. As always, be sure to carefully consider the risks and benefits when leveraging home equity.
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What is a home equity loan?
A home equity loan has a variety of uses: a way to fund big-ticket purchases, make costly home upgrades and consolidate high-interest debt.
It’s a second mortgage against your home with its own terms and interest rate that are separate from your first mortgage. By refinancing using a home equity loan, you’re borrowing against the home’s equity — the difference between the appraised value of your home and what you owe on your mortgage. You can typically borrow up to 85 percent of your home’s equity. However, your loan size depends on other financial factors, like your income and credit history, and the outstanding balance on your first mortgage.
Home equity loans typically have a repayment period of up to 30 years, just like mortgages. Home equity loan rates may be higher than those of refis. The differences, however, vary significantly from lender to lender and over time.
- Fixed rates offer certainty
- Lower rates than unsecured debt
- Long repayment terms/low monthly payments
- Interest can be tax-deductible
- Use the cash for almost any purpose
- Foreclosure risk: home is collateral
- Higher credit requirements
- 15%-20% home equity required
- Must be paid off when home is sold
- Easy to overborrow due to lump sum distribution
Home equity loan fees vary a good deal among lenders, highlighting the importance of comparing offers. While some lenders waive origination fees — often a big chunk of total closing costs — they may implement a slightly higher interest rate as compensation. And it’s likely that, as with the refi, you’ll have to pay for an appraisal and various administrative fees. In general, though, home equity loan closing costs tend to be lower than those for a refi, working out to 2 percent to 5 percent of the loan principal. That’s partly because you may incur fewer costs, but also because you’re likely borrowing a smaller amount, so percentage-based expenses — like origination fees — will be less.
Cash Out Refi vs Home Equity Loan, which one should you choose in 2023?!?
FAQ
What is the downside of a cash-out refinance?
Is a cash-out refinance the same as a home equity loan?
How is a $50,000 home equity loan different from a $50,000 home equity line of credit?
What is the monthly payment on a $50,000 home equity loan?
|
Loan amount
|
Monthly payment
|
|
$25,000
|
$166.16
|
|
$50,000
|
$332.32
|
|
$100,000
|
$673.72
|
|
$150,000
|
$996.95
|
How much equity do you need to refinance a home?
Many loan types require that you leave some equity in the home. To qualify for a cash-out refinance, Federal Housing Administration (FHA) and conventional loans require that you leave 20% equity in your home. VA loans are an exception, as they allow you to get a cash-out loan for 100% of the value of the home.
Is a home equity loan better than a cash-out refinance?
A home equity loan is easier to obtain for borrowers with a low credit score and can release just as much equity as a cash-out refinance. The cost of home equity loans tends to be lower than cash-out refinancing and can be far less complex. Home equity loans also have drawbacks, though.
How much equity do you need for a cash-out refinance?
Mortgage lenders typically allow you to borrow up to 80% of your home’s value with a conventional cash-out refinance, meaning you must maintain at least 20% equity in your home. These limits differ for government-backed loans: up to 85% for an FHA cash-out refinance and up to 100% for a VA cash-out refinance.
Is a cash-out refinance better than a HELOC?
Interest rates are generally lower for cash-out refinances than for home equity loans or HELOCs. Closing costs are generally higher for cash-out refinances, since a refinance is essentially a brand new mortgage. Closing costs for home equity loans and HELOCs are typically lower.