- Both home equity loans and payout refinance allow you to turn home equity into cash.
- A cash-out refinance replaces your existing mortgage with one with a larger balance.
- A home equity loan is considered a second mortgage and comes with an additional monthly payment.
Owning a home allows you to build equity that you can convert to cash when you need it, whether it’s for home repairs, your child’s tuition, paying off debt, or other financial needs.
Cash-out refinancing and home equity loans are two of the most popular tools available to do this. But they are not created equal. Here’s what you need to know about each to help you decide which is the best choice for your situation.
Cash-Out Refinancing vs. Home Equity Loans: At a Glance
Cash-out refinance and home equity loans allow you to access your home equity with a single lump sum payment.
The main difference between the two is:
- A cash-out refinance replaces your previous mortgage loan with a larger one. You will receive the difference between the two credits in cash.
- A home loan is a new loan on top of your existing mortgage. It comes with an additional monthly payment.
In both cases there are no restrictions on how you can use the money. Many people use cash out refinance and home equity loans to pay
or repairs. Because mortgage loans often have lower interest rates than other financial products, some homeowners see cash payout refinancing as a good way to consolidate other debt.
What is cash out refinancing?
A payout refinance works like this: You apply for a new mortgage loan that is larger than your current one. Once approved, this loan will be used to pay off your old loan and you will get the difference back in cash upon closing.
Cash-out refinancing is available with either variable or fixed interest rates with terms ranging from 15 to 30 years. Typically, your loan to value (LTV) can be up to 80% of the value of your home. There will also be
– usually around $5,000 on average.
The biggest advantage of a cash out refinance is that no additional payment is required. It also usually comes with a lower interest rate than a home equity loan.
“It’s the cheapest way to borrow against the equity in your home,” says Melissa Cohn, regional vice president of William Raveis Mortgage.
With a cash-out refinance, your mortgage interest is tax-deductible. Depending on your interest rate and loan balance, this could significantly reduce your taxable income.
The downside to payout refinancing is that it replaces your current mortgage, which could mean you are trading a lower interest rate for a higher one. There are also closure costs to consider. If you think you could sell the house soon, the expense might not be worth it.
“If you want to borrow the money long-term, cash-out refinancing makes sense,” says Cohn.
Example of a cash-out refinancing
Let’s say your house was worth $500,000 and your current mortgage loan balance was $300,000.
The cash-out refinancing process would look something like this:
- You would apply for a new mortgage loan. Since payout refinances typically allow for an LTV of up to 80%, this means you can apply for up to $400,000 in funding ($500,000 x $0.80).
- You submit the required financial documents. Lenders typically require bank statements, payslips, tax returns, and W-2s, among other things.
- Have your home appraised. In most cases, your lender will want to check the value of your home with a new appraisal.
- You would complete the loanand the new loan would be used to pay off the old mortgage balance, leaving you with a $100,000 surplus.
- You would receive that $100,000 as a lump sum within days of completion.
What is a Home Loan?
A home equity loan is a type of second mortgage. Unlike cash-out refinancing, it doesn’t replace your current mortgage loan. Instead, it’s a loan on top of your original mortgage — meaning you have two monthly payments.
Home equity loans typically have fixed interest rates and terms ranging from five to 30 years. These loans also come with closing costs, although they’re usually lower than what you’ll see with a payout refinance. Some lenders even cover them completely. In most cases, home equity loans give you access to up to 80% of your home’s value — both through your home equity loan and your main mortgage. Some lenders may have limits of up to 90% for certain borrowers.
The main disadvantage of a home equity loan is that it comes with a second monthly payment. Interest rates may also be higher and your interest expense may not be tax deductible. With home equity mortgages, you can only deduct interest if you use the funds to “buy, build, or substantially improve” your home. And even then, you’d have to break down your returns to make that deduction.
On the other hand, home equity loans allow you to keep the terms of your original mortgage, which can be good if you’re very far into your repayment plan when more of your payments go toward your principal balance rather than interest. It’s also smart if traditional mortgage interest rates are rising and you don’t want to lose the low interest rate you already have.
“For homeowners whose primary mortgage interest rate is below current market rates, a home loan may be a better choice,” said Nicole Straub, SVP and head of Discover Home Loans. “By choosing this option, they can maintain the low interest rate they have while using the equity they have in their home.”
Home loan example
Suppose the value of your home is $500,000. Since home equity loans typically allow for 80% loan-to-value ratios, you could access up to $400,000 on both your main mortgage and a new home equity loan. For example, if your current mortgage balance was $350,000, a home equity loan could likely offer you up to $50,000 in cash up front ($400,000 to $350,000).
To get your home equity loan, you would apply to your chosen lender, file paperwork, and have your home appraised. Once you’ve paid your closing costs and signed the paperwork, you’ll receive your lump sum payment a few days later. You would then begin making monthly payments on your home equity loan starting next month.
Put everything together
Both home equity loans and cash-out refinances can help you turn equity into cash. However, the best choice depends on your individual budget, the terms of your original mortgage, and your long-term plans as a homeowner.
Either way, home equity loans and cash-out refinances are likely to save you money compared to other financial products you may be considering.
“Both home equity loans and cash-out refinances are types of secured debt with an average interest rate that’s typically lower than other types of unsecured debt — like credit cards or personal loans,” Straub says.
If you are unsure which product is right for your situation, consult a mortgage broker or financial advisor. You can also ask lenders for quotes on both products and compare the two options side-by-side.