Here’s how to leverage equity in a smart way that adds value.
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.
The time may be ideal for tapping this asset for a remodeling project, debt consolidation, or new business idea. We cover just two options for putting your house up as collateral in exchange for a cash infusion.
How does a cash-out refinancing differ from a home equity loan?
Let’s start with the cash-out refinancing option. This option 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 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.
| Cash-out refinancing | Home equity loan | |
|---|---|---|
| Closing costs | 2% to 4% of the home’s purchase price | 2% to 5% percent of the cost of the home equity loan |
| Repayment terms | Up to 30 years | From 5 to 20 years |
| Maximum loan amounts | Borrow up to 80% of your home’s value | Borrow up to 95% of your home’s value across your first and second loans |
| Interest rates | Fixed or variable | Fixed |
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. The remainder is your home’s equity.
What are the benefits of a cash-out refinancing and a home equity loan?
Cash-out refinancing
- Lower interest rate compared to a home equity loan
- Interest may be tax-deductible
- Only one loan payment
- Lump sum to spend how you wish
Home equity loan
- Fixed interest rate and monthly payment
- Interest may be tax-deductible
- Lump sum to spend how you wish
What are the drawbacks of a cash-out refinancing and a home equity loan?
Cash-out refinancing
- Higher closing costs than a home equity loan
- Restarts mortgage process, leading to a longer time to repay your home loan
- If equity falls under 20%, private mortgage insurance may be required
- You can lose your home if you default
Home equity loan
- Two monthly payments
- Numerous fees and closing costs
- You can lose your home if you default
Which option is better suited for me?
While you ultimately have to determine which loan fits your circumstances best, consider your budget against your financial goals.
For example, think about how much money you need for that home renovation project, debt consolidation or new business. If it’s more than 80% of your home’s value, you’d need to choose a home equity loan over a cash-out refinancing.
Also, look at the interest rate on your existing mortgage. If it’s low, then you might not want to lose that by trading it in for a new loan with a potentially higher rate. Instead, a home equity loan could result in a stronger interest rate.
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 a cash-out refinancing and a home equity loan, you’re better positioned to narrow down the best loan to leverage your home’s equity.