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If you’re a homeowner with a good amount of equity in your property, then a cash-out refinance or home equity loan could offer money when you need it.
Whether you’re facing high medical bills or just looking to cover a kitchen remodel, both financing options can give you the cash you need to pay the bills, all by tapping your home equity.
Here’s a look at these loan products more in-depth — as well as when homeowners may want to use them:
- How a cash-out refinance works
- How a home equity loan works
- Cash-out refinance vs. home equity loan
- How to choose between a cash-out refinance and a home equity loan
How a cash-out refinance works
A cash-out refinance is a method of replacing your existing mortgage loan. It’s a type of mortgage refinance where you apply for a new mortgage that’s larger than your current loan balance. Once approved, the new loan is used to pay off your old mortgage and any loan costs and closing costs you choose to pay, and you’ll receive the difference between the two loans in cash (this is the “cash-out” portion of the transaction). You’ll also get a new monthly payment based on your new loan terms and balance.
How a home equity loan works
A home equity loan is what’s called a second-lien mortgage. It allows you to borrow money based on how much equity you have in the home, but instead of replacing your existing loan, it’s done through a second, completely separate and additional mortgage. You’ll pay it down monthly, just like you do with your current mortgage (meaning you’ll have two monthly payments total).
Home equity loans come with more of an inherent risk for mortgage lenders. This added risk typically means home equity loans can be harder to qualify for and come with higher interest rates. Because they’re a second mortgage, the lender doesn’t have a first-priority claim to the property if you fail to make payments, so this increases the chance of financial loss should you default on your loan payments.
Cash-out refinance vs. home equity loan
If you’re a homeowner and you’re in need of cash, either a cash-out refinance and home equity loan could be a solid option. The best choice really depends on your personal situation, budget, goals, and more.
Here’s a quick look at how the two types of loans measure up.
Similarities between cash-out refinancing and home equity loans
The biggest similarity between cash-out refinancing and a home equity loan is that they both allow you to leverage the equity you’ve built up in your home.
The other major similarities are that:
- Both give you a lump-sum payment. You’ll get cash immediately after closing — not in installments or over time.
- Both allow you to use the money for any purpose. You can use the funds for home improvements, tuition, medical bills, and many other costs.
- You might be able to deduct the interest paid on both loans. There are scenarios in which you can deduct your interest costs from both loans on your annual tax returns.
Differences between home equity loan vs. cash-out refinance
Though they share a few similarities, cash-out refinances and home equity loans function very differently. For one, cash-out refinances replace your existing loan (meaning one monthly payment), while home equity loans add a second payment to your monthly bills.
The other major differences are:
- A cash-out refinance could come with an adjustable rate, while home equity loans are typically fixed-rate. With an adjustable-rate loan, you could see your rate and payment rise over time.
- Cash-out refinances typically offer lower interest rates than home equity loans. Home equity loans are riskier and typically come with higher rates.
- Cash-out refinances typically come with higher closing costs than home equity loans. Many home equity loans don’t have closing costs at all.
- A home equity loan could be harder to qualify for than a cash-out refinance. Lenders take on more risk with home equity loans, so they’re more strict about who they’ll lend to.
When it makes sense to get a home equity loan
A home equity loan generally makes the most sense if you know you can pay off the loan quickly. Since these loans come with higher interest costs, this can minimize how much added interest you’ll pay to borrow the money.
Home equity loans can also be a good idea when:
- You can comfortably handle a second monthly payment
- Market interest rates are higher than the rate on your current mortgage (and you don’t want to lose that rate by refinancing)
- You plan to use the money toward home improvements (you can only deduct the interest on home equity loans if used for these purposes)
When it makes sense to get a cash-out refinance
Cash-out refinancing is your best bet when you’re on a strict budget and need a consistent and singular payment each month.
A cash-out refinance can also be a good move if:
- Your credit or financial profile isn’t great and you’re not sure you could qualify for a home equity loan
- You’re consolidating debt and want a low interest rate
- Market interest rates are lower than the rate on your current mortgage and you want to take advantage of the low rates
How to choose between a cash-out refinance and a home equity loan
The right choice really depends on your personal finances, budget, intended use for the funds, and your repayment timeline. Whichever you choose, make sure to shop around for your loan.
If you’re considering a cash-out refinance, Credible Operations, Inc. makes it easy — you can compare your prequalified rates from our partner lenders in the table below by filling out a single form.