Home Equity Loan Rates vs Mortgage Rates: What’s the Difference?

Homeowners looking to tap into their home’s equity often face a choice between a home equity loan or a cash-out mortgage refinance. While both allow you to withdraw cash, there are some key differences between these products that homeowners should understand.

In this comprehensive guide, we’ll compare home equity loan rates, mortgage rates, terms, costs, and more, so you can make an informed decision when choosing between these two common ways of accessing your home’s equity.

Home Equity Loan Rates

A home equity loan is a type of second mortgage that allows homeowners to borrow against the equity they have built up in their home

With a home equity loan, you’ll receive a lump sum of cash upfront, which you’ll pay back over a fixed term, usually between 5-20 years. The interest rate is also fixed for the life of the loan.

Current home equity loan rates range from around 5% to 8% for prime borrowers, depending on factors like your credit score, loan-to-value ratio, and overall financial profile. Rates are higher for borrowers with lower credit scores or higher debt-to-income ratios

Pros of home equity loan rates:

• Fixed interest rates and payments provide predictability
• Typically lower rates than other loan types like personal loans or credit cards
• Interest may be tax deductible (consult a tax pro)

Cons:

• Rates higher than first mortgage rates
• Rising home values don’t lower payments like with a HELOC

Mortgage Rates

With a cash-out refinance mortgage, you replace your existing first mortgage with a new, larger loan. The proceeds from the new loan pay off your old mortgage, and any excess cash is returned to you as a tax-free cash payment.

Because it’s a first mortgage, cash-out refinance rates are lower than home equity loan rates. Expect rates around 4-6% for prime borrowers right now. Rates rise as your credit score and financial profile weaken.

Pros of cash-out mortgage rates:

• Typically the lowest rates for borrowing large sums
• Can lower monthly payments by refinancing to a lower rate
• Lets you withdraw almost all your home equity

Cons:

• Resets mortgage term to 30 years
• Closing costs on entire loan amount

Loan Amounts

The amount of cash you can tap depends on how much equity you’ve built up in your home. Equity is your home value minus what you owe on your mortgage.

With a cash-out refinance, you can withdraw up to 80% of your home’s value, less your current loan balance. So if your home is worth $500,000 and you owe $200,000, you could get a new loan for up to $400,000 and pocket $200,000 cash.

Home equity loans allow combined loan amounts up to 80-85% of your home’s value. So with 20% equity, you could get a home equity loan for $80,000 on the above example.

Cash-out refinances permit higher loan amounts overall. But home equity loans let borrowers with low equity withdraw cash.

Loan Terms

Cash-out refinance terms are usually 20-30 years. This resets your mortgage term back to the beginning if you had less than 30 years left.

Home equity loans offer more flexibility with typical terms of 5, 10, 15 or 20 years. Shorter terms build equity faster but have higher monthly payments.

So while refinances provide lower rates, home equity loans let you pay off your borrowing faster if you select a shorter term. Run the numbers to see which saves more on interest.

Closing Costs

Both loans charge closing costs, which includes origination fees, appraisal fees, title fees and more. But the way these costs are calculated differs.

With a home equity loan, closing costs range from 2-5% of the amount borrowed. So if you borrow $50,000, expect to pay $1,000 to $2,500 in fees.

Cash-out refinance costs are based on the entire new loan amount. If you refinance $300,000, closing costs could range from $6,000 to $15,000. However, these can often be rolled into the new loan amount.

Even with a higher rate, home equity loans usually have lower overall closing costs.

Tax Benefits

One potential advantage of a cash-out refinance is that you may be able to deduct mortgage interest if you use the funds for home improvements. This deduction has narrowed but still applies to some filers.

Interest on home equity loans up to $100,000 is also tax deductible. So both products offer possible deduction benefits. Consult a tax pro to understand how tax laws apply to your situation.

When a Home Equity Loan Makes Sense

A home equity loan can be a better option than a cash-out refinance in several cases:

• You have an existing mortgage with a very low rate or short remaining term. A home equity loan avoids resetting these terms.

• You need a smaller loan amount of $50,000 or less. Closing costs on a refinance would be disproportionately high.

• You want a shorter repayment term like 5-15 years. This builds equity faster.

• Your credit score is low, making refinance rates much higher. The home equity loan rate premium is smaller.

• You need funds quickly. Home equity loans can close faster than refinances.

When a Cash-Out Refinance Makes More Sense

Consider a cash-out refinance if:

• Your current mortgage rate is higher than today’s rates. You can lower your payments.

• You need to withdraw close to the maximum amount of equity from your home.

• You are okay with resetting your mortgage term back to 30 years.

• Your credit is very strong. The rate premium for a home equity loan is larger.

• You want to consolidate other high-rate debts alongside withdrawing cash.

Shop Multiple Lenders

No matter which option you choose, always compare loan estimates from multiple lenders. Even a small difference of 0.25% in rates can save you thousands over the loan’s term.

Online lenders, credit unions, and mortgage brokers are good options alongside big banks when shopping for a home equity loan or cash-out refinance. Apply with several lenders to find the best deal.

Weigh the Long Term Costs

Look at both options’ total interest costs over the loan’s full term. Home equity loans often cost less in total interest because of their shorter terms, despite higher rates.

But run the numbers based on your specific loan details, credit profile and monthly budget to see which option saves you the most over the long run.

Consult a Financial Professional

These are complex products with long term implications. Before choosing between a home equity loan and cash-out refinance, have an in-depth discussion with a loan officer or financial advisor.

Ask them to help you analyze the pros and cons for your specific financial situation. Their guidance can help ensure you select the optimal loan product.

Know Why You’re Borrowing

Finally, understand why you need to borrow funds from your home equity before selecting a product. Will the money be used for a high-return remodel or investment? Or are you borrowing to cover everyday expenses?

Tapping home equity can be wise if done carefully and for the right reasons. But it also carries risk, so proceed thoughtfully.

The Bottom Line

Home equity loans and cash-out refinance mortgages both allow homeowners to leverage their equity for cash. But notable differences exist in terms of interest rates, terms, costs and tax benefits.

Carefully compare these options using personalized rate quotes. Weigh the long term costs based on your finances and goals. With prudent analysis, you can determine the better home equity borrowing method for your needs.