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Cash-out refinance vs. home equity loan
If you're looking to leverage equity in a smart way that adds value, consider these two options.
They say your home is where your heart is. And after recent growth in the real estate market, it’s also where you may find a significant asset.
Both cash-out refinancing and home equity loans use your house as collateral in exchange for a cash infusion. But which one is best for you depends on how much equity you have and what interest rate you qualify for.
How do cash-out refinancing and home equity loans compare?
Cash-out refinancing takes your current home loan and refinances it into a larger mortgage, providing you with a cash amount equivalent to the increase in your mortgage amount. You can choose from a fixed or adjustable rate as well as numerous other terms. The result is an entirely new loan agreement with a different term, interest rate and repayment schedule.
In contrast, a home equity loan taps into your home’s equity to create a new loan that’s in addition to your current mortgage. If approved, you’re paying two loans each month. This option typically comes with a fixed interest rate but offers a range of repayment terms.
What is equity?
In short, it’s the part of your home that you own after subtracting any debts associated with your home, like a mortgage, from your home’s fair market value. For example, if your home is worth $200,000 and you owe $150,000 to your mortgage lender, you’d have $50,000 in equity.
Choose a cash-out refinance if:
You’re eligible for a lower interest rate than you have on your current mortgage. For example, if you took out a mortgage with a 6% interest rate but are now eligible for a 4% interest rate on a new cash-out refinance mortgage, you can save money on interest in the long run.
Avoid this loan type if:
You can’t afford the closing costs. Cash-out refinancing generally has much higher fees and closing costs than home equity loans. And while some lenders will let you roll those costs into the loan, that means you’ll end up paying interest on the fees.
Choose a home equity loan if:
You have a lot of equity built up in your home and you’re not eligible for a lower interest rate. Home equity loans generally require more equity to qualify, and you may need a better credit score. But if interest rates have gone up since you took out your original mortgage, a home equity loan will generally be a better financial move.
Avoid this loan type if:
You have trouble keeping track of multiple bills. You’ll need to pay back two mortgages, and you could lose your home if you default on either one.
Bottom line
Any decision that involves a significant amount of money and repayment responsibility can be stressful. However, by comparing the benefits and risks of cash-out refinancing and home equity loans, you’re better positioned to narrow down the best loan to leverage your home’s equity.
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