Cash Out Refinance vs. Home Equity Loans

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Point of Interest

A cash-out refinance and a home equity loan are two different ways of borrowing money against the equity you’ve built in your property. But while both will give you access to cash, these two loan types vary greatly for borrowers.

From carrying out home improvements to helping children with a down payment for their own place, there are many reasons homeowners may want to get quick access to some additional cash. As a homeowner, you build equity in your home with your payments each month, and once you’ve paid off enough of your home, you can borrow against that amount with a home equity loan or a cash-out refi. 

When it comes to borrowing against the equity, these two choices — cash-out refinance vs. home equity loans — can be minefields when deciding which is best for you. You’ll need to know what a cash-out refinance and home equity loan are and how they differ. This information can help you understand the better option for your circumstances.

Refinancing your home

What is a cash-out refinance? A cash-out refinance is a refinance that pays off your existing mortgage and sets you up with a brand-new loan for an amount that’s more than you owed on your old loan. The total loan amount you’re given access to will be determined by how much equity you have in your home. 

In general, lenders will let you borrow from 75% to 90% of your equity as cash when completing a cash-out refi. You’ll be given the extra amount in cash, and will be responsible for paying back the new, increased amount in one payment according to the new loan terms. 

The fresh arrangement may also have a different type of loan, a new lender, a different interest rate or be set up for a different term. In short, a cash-out refinance uses a new mortgage loan to pay off your existing one and starts you out with a completely fresh deal while giving you access to a portion of the equity you’ve built in your home.

Home equity loans

Home equity loans also give you access to the equity you have in your home, but unlike cash-out loans, which replace your original mortgage loan, a home equity loan is a second mortgage loan on your house. Rather than rolling the equity you’re borrowing into a new home loan, this option stacks a new, secondary loan on top of your initial mortgage loan.

As with cash-out loans, these loans are issued for a percentage of your equity — again, up to 90% depending on the lender, and the new loan is separate from your mortgage. You pay it back separately according to the terms of the loan and the interest rate. 

Pros and cons

Cash-out refinance

Pros

  • The possibility of getting a better interest rate with your new mortgage loan if you took out your mortgage at a time when rates were higher.
  • You’ll only pay one interest rate on both the mortgage and the cash you borrowed — which are lumped together in the same loan.
  • Using the money you cashed out to pay off high interest debt can have a positive impact on your credit score.
  • Your mortgage debt is tax-deductible.

Cons

  • As with any debt secured against your property, your home is at risk of foreclosure should you fail to keep up with payments.
  • Your new loan product will come with a fresh set of terms, fees and rates, so make sure it all adds up to saving before signing on the dotted line.
  • The decision to secure a loan against your home should never be taken lightly — especially if that cash you’re borrowing from your equity will increase the size and term length of your mortgage.

Home equity loans

Pros

  • Because you are using your property as collateral, you will be able to get more favorable rates compared to a personal unsecured loan.
  • You won’t have to restart your existing home loan term or lose your low interest rate by refinancing to a new mortgage loan with a higher rate.
  • As with a cash-out refinance, if you use the money for home improvements, the interest is tax-deductible.
  • Home equity loans can be used for any purpose.

Cons

  • As with the cash-out refinance option, your home may be at risk if you fail to keep up with your repayment schedule.
  • You’ll be taking on a secondary loan, which will have to be paid back with interest on top of your existing mortgage loan.
  • If the value of your home declines, you could find yourself in negative equity, which is where the finance secured against your property exceeds its value. This practice is sometimes referred to as “going underwater” or “upside-down,” and was one of the main factors that contributed to the 2008 sub-prime mortgage crash.

How to choose?

When it comes to cash-out refinance vs. home equity loans, there is no one right choice. The best option will depend on your personal circumstances and the ultimate goal you have for the cash you’re borrowing.

If you aren’t worried about restarting your loan term with a refinance, it can be smarter to opt for a cash-out refinance over a home equity loan. This allows you to pay one interest rate on your home loan and the equity you borrowed against.

If you’re concerned about restarting your loan term or the interest rates are higher than they were when you initially took out your home loan, you may want to opt for a home equity loan instead. This keeps your original mortgage loan and terms intact but still allows you to access the equity you’ve built in your home.

Ultimately, any loan product should be taken out with caution, and it always pays to shop around and consult an independent financial advisor.

The final word

Choosing between a cash-out refinance and home equity loan is a difficult question to answer, and you need to carefully consider every angle before settling on a final decision. There are some situations where one will make sense over the other, so be sure to carefully weigh your needs and what you envision for your payments or existing mortgage loan before you opt for one over the other. 

FAQ

Is it better to do a cash out refinance or a home equity loan?

The answer to this will depend on several factors, including what the finance is intended for and your personal circumstances. If you’ve only recently taken out your mortgage loan, you may not be as concerned about refinancing to a new loan with a new term. If you’re down to your last ten years or so on your home loan, you may want to opt for a second loan instead. 

Is it smart to take out a home equity loan?

Taking out debt is always a risk and should never be taken lightly. However, it is sometimes an avoidable reality of life. Opting for a home equity or cash-out refi can be a smart way to borrow money with lower interest than you would get with most other loan products.

What is cash-out home equity?

Cash-out home equity is the same thing as cash-out refinancing — a new mortgage with new terms and a higher amount will pay off your old mortgage, and you will be given access to the extra cash from your equity.

Gary Smith

Contributing Writer

As senior editor and full-time writer for markITwrite I have the privilege of creating articles on a vast range of topics, from marketing and business to technology and politics. I treat each new project with the utmost care and attention, whether researching a topic or putting pen to figurative paper. Outside work, I am an active participant in the theatre and believe strongly in getting involved with my community.