What You Should Know About Cash Out Refi vs. Home Equity Loans

Intro: If you’re thinking about borrowing against the equity in your home, you may wonder if a cash-out refinance or a home equity loan is the better option. Here’s what you need to know about each one. A cash-out refinance lets you borrow more than your current mortgage balance and use the extra money for whatever you want. A home equity loan is a second mortgage that lets you borrow up to 85% of your home’s value, minus what you still owe on your first mortgage. 

Both a cash-out refinance and a home equity loan has pros and cons, so it’s essential to understand the key differences before making a decision.

Cash-Out Refinance vs. Home Equity Loan: The Basics

A cash-out refinance is a mortgage refinancing option where the new loan is for a larger amount than the existing loan to convert home equity into cash. The borrowed money can be used for any purpose, such as consolidating debt or making home improvements.

A home equity loan is a separate loan that gives you access to cash based on the equity you’ve built up in your home. Home equity loans are usually second mortgages, meaning your home secures them just like your primary mortgage.

The main difference between a cash-out refinance, and a home equity loan is that a cash-out refinance your existing mortgage, while a home equity loan is a separate loan that gives you access to the equity you’ve built up in your home.

With a cash-out refinance, you’re essentially taking out a new mortgage to replace your existing mortgage. This means you’ll have two mortgages to pay for a period of time-your old mortgage and your new cash-out refinance.

With a home equity loan, you’re taking out a second mortgage on your home. The interest rate on a home equity loan is usually higher than the interest rate on a primary mortgage because the lender considers it a higher-risk loan.

Both cash-out refinances and home equity loans come with their own set of pros and cons.

Pros of a Cash-Out Refinance

  • You may be able to get a lower interest rate than you currently have on your mortgage
  • You can use the equity you’ve built up in your home to consolidate other debts or make home improvements

Cons of a Cash-Out Refinance

  • You’ll have to pay closing costs on the loan
  • You may end up with a higher monthly mortgage payment if you extend the term of your loan
  • You may not be eligible if you have poor credit or are underwater on your mortgage

Pros of a Home Equity Loan

  • The interest rate is usually lower than the interest rate on a personal loan or credit card
  • You may be able to deduct the interest you pay on your taxes

Cons of a Home Equity Loan

  • You could lose your home if you didn’t make the payments
  • The interest rate is usually higher than the interest rate on a primary mortgage
  • You’ll have to pay closing costs on the loan
  • You may not be eligible if you have poor credit or no equity in your home

Cash-Out Refinance vs. Home Equity Loan: How They Work

A cash-out refinance replaces your existing mortgage with a new loan for more than what you owe on your home. The difference goes to you in cash; you can use it for any purpose.

To be eligible for a cash-out refinance, you’ll need to have enough equity in your home to qualify for the loan amount. Lenders typically require that you have at least 20% equity in your home before they approve a cash-out refinance.

With a home equity loan, the lender approves you for a set loan amount based on the equity you’ve built up in your home. You can use the loan for any purpose and make fixed monthly payments. Home equity loans typically have a term of 5 to 30 years.

Comparing a cash-out refinance and home equity loan, the main difference is how you use the funds from the loan. With a cash-out refinance, you’re using the money to pay off your existing mortgage and get cash back. With a home equity loan, you’re using the loan to finance a specific goal or project.

The approval process for a cash-out refinance is typically simpler than for a home equity loan because you’re already qualified for the mortgage. For a home equity loan, you’ll need to qualify based on the equity in your home as well as your income and credit score.

Cash-Out Refinance vs. Home Equity Loan: Benefits and drawbacks

A cash-out refinance has some significant benefits over a home equity loan, including lower interest rates and potentially lower closing costs. But there are also some drawbacks, such as paying private mortgage insurance (PMI) if your loan-to-value ratio is greater than 80%.

A cash-out refinance‘s biggest benefit is taking advantage of lower interest rates. Interest rates on cash-out refinance tend to be lower than rates for home equity loans, although they may be higher than your current mortgage rate if you’re refinancing a conventional loan.

Another benefit of a cash-out refinance is that it may allow you to avoid paying private mortgage insurance (PMI). If your loan-to-value ratio is 80% or less, you’ll typically avoid having to pay PMI. But if you’re taking out a larger loan and your loan-to-value ratio exceeds 80%, you may be required to pay PMI.

One potential drawback of a cash-out refinance is that it could take longer to pay off your loan than a home equity loan. Cash-out refinances typically have 15- or 30-year terms, while home equity loans usually have terms of 5 to 20 years. So a cash-out will take longer to pay off than a home equity loan, and you’ll have to make higher monthly payments.

Another potential drawback is that you may end up with a higher interest rate than you would with a home equity loan. If interest rates have gone up since you took out your original mortgage, you may have a higher rate on your new loan.

And finally, if you’re already facing foreclosure, a cash-out refinance probably won’t be an option since lenders typically won’t approve loans for more than the value of your home.

So there are some potential drawbacks to consider before deciding to do a cash-out refinance. But a cash-out refinance could be a good option if you can get a lower interest rate and avoid paying PMI.

The bottom line

A cash-out refinance is a mortgage refinancing option where the new loan is for a larger amount than the existing loan to convert home equity into cash. The borrowed money can be used for any purpose, such as consolidating debt or making home improvements.

A home equity loan is a separate loan that gives you access to cash based on the equity you’ve built up in your home. Home equity loans are usually second mortgages, meaning your home secures them like your primary mortgage.

Cash-out refinances and home equity loans have pros and cons, so it’s important to understand how they work before you decide which one is right for you. If you’re unsure which option is best for you, talk to one of our agents to get more information.

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