When homeowners need extra cash, two popular options come up: a Cash-Out Refinance and a Home Equity Loan. Both allow you to tap into your home’s equity, but they work differently and serve different needs. Choosing the right option can save you money and stress, so understanding the differences is key. In this post, we’ll break down what Cash-Out Refinance means, compare it to Home Equity Loans, and help you decide which is best for your situation.
What is a Cash-Out Refinance?
A Cash-Out Refinance is a way to replace your existing mortgage with a new, larger one. You borrow more than what you currently owe, and the extra amount comes to you in cash. Think of it as refinancing your home loan but taking some money out for other expenses like home repairs, paying off debt, or investing in something new.
With a Cash-Out Refinance, you get one loan with a potentially lower interest rate than other types of borrowing because it’s secured by your home. The new loan pays off your old mortgage, and you get the difference as cash. This means your monthly mortgage payment may increase because you owe more money overall.
What is a Home Equity Loan?
A Home Equity Loan, sometimes called a second mortgage, is a separate loan that lets you borrow against the equity you’ve built in your home. Unlike refinancing your first mortgage, this loan is in addition to your current mortgage. You get a lump sum of money upfront, which you pay back over time with a fixed interest rate.
Home Equity Loans are often used for one-time expenses like major home renovations, education costs, or consolidating high-interest debt. Since it’s a second loan, you’ll have two separate payments: one for your original mortgage and one for the Home Equity Loan.
Key Differences Between Cash-Out Refinance and Home Equity Loan
Understanding the main differences helps homeowners pick what fits their financial goals better.
Loan Structure and Payments
A Cash-Out Refinance replaces your existing mortgage with a new loan, so you make just one monthly payment. This can simplify finances and sometimes lower your interest rate if rates have dropped since you took your original mortgage. However, because you’re borrowing more money, your monthly payments will likely increase.
A Home Equity Loan is a second loan, so you have two monthly payments to manage. The payments on a Home Equity Loan are typically fixed, which means they stay the same throughout the loan term. This predictability can help with budgeting.
Interest Rates
Generally, Cash-Out Refinances offer lower interest rates compared to Home Equity Loans. That’s because you’re refinancing your primary mortgage, which usually has better rates due to the larger loan amount and longer term.
Home Equity Loans often have higher interest rates because they are considered riskier for lenders — you’re taking on additional debt secured by your home, but it’s secondary to your first mortgage.
Loan Terms
Cash-Out Refinances typically come with loan terms of 15 to 30 years, similar to a standard mortgage. This longer term means smaller monthly payments but more interest paid over time.
Home Equity Loans usually have shorter terms, like 5 to 15 years, meaning higher monthly payments but less interest overall.
Closing Costs and Fees
Refinancing your mortgage with a Cash-Out Refinance often involves higher closing costs because you’re essentially taking out a new mortgage. These costs can include appraisal fees, loan origination fees, title insurance, and more.
Home Equity Loans may have lower upfront fees, but this varies by lender. It’s important to ask about all potential costs before choosing either option.
When is Cash-Out Refinance the Better Choice?
If current mortgage interest rates are lower than what you originally paid, a Cash-Out Refinance can be a smart move. It lets you tap into your home’s equity while potentially lowering your overall interest rate. This can save money in the long run, even if your monthly payment increases.
Cash-Out Refinances also work well if you want to simplify your debt by combining your mortgage and the cash you take out into one loan. For example, if you have high-interest credit card debt, using a Cash-Out Refinance to pay it off can reduce your interest costs.
Another situation is when you plan to stay in your home for several years. The closing costs on a Cash-Out Refinance make more sense when spread out over a long time.
When is a Home Equity Loan the Better Choice?
If mortgage rates are high or haven’t changed much since you took out your original loan, a Home Equity Loan might be a better option. You won’t have to refinance your entire mortgage, so your current loan stays intact with its favorable terms.
Home Equity Loans can be a great choice for borrowers who need a lump sum for a short-term project and want a fixed repayment schedule. Because of their shorter terms, you’ll pay off the loan faster and avoid tying up your home in a bigger mortgage.
Also, if you don’t want to go through the hassle or expense of refinancing your mortgage, a Home Equity Loan can be quicker and less costly upfront.
Potential Risks of Both Options
Both Cash-Out Refinance and Home Equity Loans use your home as collateral. If you miss payments, you risk foreclosure. So, it’s crucial to borrow responsibly and make sure you can handle the new debt.
Additionally, increasing your loan amount through either option means you owe more money overall. This could affect your ability to sell your home or refinance in the future.
How to Decide What’s Best for You
Start by comparing current mortgage rates to your existing rate. If rates are lower, Cash-Out Refinance may save you money.
Next, calculate your monthly budget to see if you can handle a higher mortgage payment or an extra loan payment. Consider how long you plan to stay in your home and your financial goals, like paying off debt or funding home improvements.
Speak with lenders or financial advisors to get personalized advice and loan estimates for both options. They can help clarify which choice offers the best terms and fits your needs.
Conclusion
Both Cash-Out Refinance and Home Equity Loans are effective ways to use your home’s equity for cash. The best choice depends on your financial situation, current interest rates, and how you want to manage your loans. Cash-Out Refinance can lower your interest rate and simplify payments but often comes with higher upfront costs. Home Equity Loans offer a separate loan with predictable payments and possibly lower fees but usually at higher interest rates. Weigh these factors carefully to make the smartest decision for your finances.
If you’re considering tapping into your home’s equity, take the time to explore both options. Getting the right loan can improve your financial health and help you reach your goals faster.
Ready to learn more about Cash-Out Refinance and Home Equity Loans? Contact a trusted lender today to discuss your options and get personalized advice!