Cash-out refinancing allows homeowners to borrow more than their current mortgage balance and receive the difference in cash, while a home equity loan is a lump sum loan based on the equity in the home.
Homeowners should know the various ways they can tap into their home equity to fund renovation projects or pay for unexpected expenses. Two of the most popular ways of doing this are a cash-out refinance and home equity loans, both of which provide you with a lump sum payment. But who’s the winner in the cash-out refinance vs. home equity loan debate?
The answer depends on your financial situation and goals. We’ll explain the pros and cons of both financial products and provide input from two real estate professionals to help you decide which one is right for you.
- What is a Cash-Out Refinance?
- Pros
- Cons
- See All 11 Items
What is a Cash-Out Refinance?
A cash-out refinance allows you to replace your current mortgage with a new one, and the difference between the two is paid out in a lump sum. Here’s how it works.
It starts with your home’s equity or the value you’ve built up in your property. To determine your equity, simply subtract your mortgage’s balance from the value of your home. Let’s say your home is valued at $200,000 and you owe $125,000 on the mortgage. That means you have $75,000 in equity ($200,000 - $125,000 = $75,000).
With a cash-out refinance, you take out some of that equity and add that to your mortgage balance. Using the previous example, if you wanted to access $25,000 of your home’s equity, you would work with a lender and borrow $150,000. It would pay off your previous loan balance of $125,000, and you’d receive $25,000 soon after closing.
You’d still only have a single mortgage payment. You’re just replacing your original mortgage with a new one.
“This option can result in a lower interest rate, but it also extends your mortgage term,” says Tim Gordon, a San Diego-based real estate investor.
RELATED: Best Cash-Out Refinance Lenders
Pros
- You can use the proceeds from a cash-out refinance for whatever you want.
- You can use the cash-out refinance to pay off high-interest debt. This works best when mortgage rates are low and if you’re committed to not accumulating more high-interest debt.
- You can lower your interest rate.
- While negotiating a cash-out refinance, you can negotiate new loan terms that better fit your financial situation while accessing needed cash.
Cons
- Cash-out refinances are secured by your home, and nonpayment could result in foreclosure
- Closing costs are still involved
- May extend your loan term
What is a Home Equity Loan?
A home equity loan is a second mortgage, which means it’s secured by your home. You borrow a lump sum based on the equity in your home and make monthly payments to repay the loan.
“A home equity loan provides the borrower with one lump sum and typically has fixed-rate payments,” says Sarah DeFlorio, vice president of Mortgage Banking at William Raveis Mortgage. “This type of loan is great for someone who needs to manage their repayment and is operating off of a fixed income.”
You can typically borrow up to 80% of the equity in your home. If you have $75,000 in equity, you could borrow up to $60,000. These loans typically have a fixed interest rate, which means the interest rate and monthly payments don’t change. Lenders offer a variety of terms, so you could repay the loan over five to 20 years or more.
RELATED: Best Home Equity Loan Rates
Pros
- There are no limitations on how you use the loan funds.
- You can consolidate debt
- Fixed interest rates
- Lower interest rate than credit cards or personal loans
Cons
- A home equity loan is a second mortgage, so if you’re unable to make payments, your home could be at risk, even if you keep up payments on your primary mortgage.
- A home equity loan is an additional loan payment, which means it’s one more payment to remember and manage every month.
- Closing costs are also part of the deal
Cash-Out Refinance vs. Home Equity Loan
- Cash-out refinancing typically has lower interest rates compared to home equity loans because it replaces the existing mortgage with a new one, whereas home equity loans are an additional lien on the property.
- Home equity loans have fixed interest rates and monthly payments, while cash-out refinancing can have variable interest rates and longer loan terms.
- Both options can be used for home improvement projects, debt consolidation or other large expenses, but it’s important to consider the fees, terms and repayment plans before deciding between the two.
| Cash-Out Refinance | Home Equity Loan | |
| Funding | Lump sum payment | Lump sum payment |
| Repayment | Replaces your mortgage with a new one | Acts like a second mortgage and uses your house as collateral |
| Interest Rates | Fixed or adjustable rate comparable to mortgage rates | Slightly higher than mortgage interest rates |
| Closing Costs | 2% to 5% the principal loan | 2% to 5% the principal loan |
How to Choose Between a Cash-Out Refinance and Home Equity Loan
Which home equity product is right for you? That depends on your situation and your personal preferences. If you only want to manage one payment or want to secure better mortgage terms, a cash-out refinance might be best.
If you want to keep your loan separate from your primary mortgage, a home equity loan might be best. For example, if you have a low interest rate on your primary mortgage or have been paying on it for decades, it may be best to leave that mortgage alone and take out a home equity loan.
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who has won awards for his coverage of the New York City economy. He has navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
For this story, we worked with San Diego-based real estate investor Tim Gordon and Sarah DeFlorio, vice president of Mortgage Banking at William Raveis Mortgage, a Northeast-based mortgage lender and broker.
Frequently Asked Questions
What is the difference between a cash-out refinance and a home equity loan?
A cash-out refinance replaces your existing mortgage with a new, larger one and pays you the difference, while a home equity loan acts as a second mortgage that, like your primary home loan, uses your house as collateral.
What are the disadvantages of a cash-out refinance?
The disadvantages of a cash-out refinance include expensive closing costs, lengthening your loan term and potentially higher interest rates.
What is the downside of a home equity loan?
The biggest downside to a home equity loan is that it’s a second mortgage that uses your house as collateral, so you risk losing your home even if you maintain payments on the primary loan.
Sources
- Sarah DeFlorio, vice president of Mortgage Banking at William Raveis Mortgage
- Tim Gordon, real estate investor and financial expert at Gordon Buys Homes
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.