Cash-Out Refinance Vs. Home Equity Loan: What’s The Difference?
Your home is an investment, and the equity in your home is something you can and should use to reach your financial goals. Cash-out refinances and home equity loans are both ways you can get cash from your home to do things like renovate your home, pay for tuition or consolidate debt. Let’s look at the differences between cash-out refinances and home equity loans so you can pick the one that’s right for you.
What Is A Cash-Out Refinance?
A cash-out refinance is a new first mortgage with a loan amount that’s higher than what you owe on your house.
You might be able to do a cash-out refinance if you’ve had your loan long enough that you’ve built equity. But most homeowners find that they’re able to do a cash-out refinance when the value of their home climbs. If you suspect that your home value has risen since you bought your home, you may be able to do a cash-out refinance.
How Does A Cash-Out Refinance Work?
When you do a cash-out refinance, you replace your existing mortgage with a new one. The loan amount on the new mortgage is higher than the amount you currently owe. At closing, you pocket the difference between your new loan amount and your current loan balance (less the equity you’re leaving in your home and any closing costs and fees, of course).
The cash you get from a cash-out refinance is tax-free and can be used in any way you like. Most homeowners who do a cash-out refinance use the money for renovations, but the money is yours to use however you see fit.
When you do a cash-out refinance, you usually can’t get a loan for the entire value of the home. Many loan types require that you leave some equity in the home. FHA loans require that you leave 15% equity in the home, while some conventional loans require 20%. VA loans are an exception as they allow you to get a cash-out loan for 100% of the value of the home.
Here’s an example: Your home is worth $200,000 and you owe $100,000 on your mortgage. To take cash out, you need to leave 20% equity ($40,000) in the home. If you were to refinance your home with a new loan amount of $160,000, you’d get to pocket $60,000, minus closing costs and fees.
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What Is A Home Equity Loan?
A home equity loan is a second loan that allows you to borrow against the equity in your home.
Unlike a cash-out refinance, a home equity loan doesn’t replace the mortgage you currently have. Instead, it’s a second mortgage with a separate payment. For this reason, home equity loans tend to have higher interest rates than first mortgages.
How Does A Home Equity Loan Work?
When you get a home equity loan, you’re getting an entirely separate loan from your mortgage. This means that none of the loan terms for your original mortgage will change. Once the home equity loan closes, you’ll receive a lump sum payment from your lender, which you’ll be expected to make payments on.
Lenders will rarely allow you to borrow 100% of your equity for a home equity loan. The maximum amount you can borrow varies depending on the lender, but it’s usually between 75% and 90% of the value of the home.
Similarities Between Cash-Out Refinances And Home Equity Loans
- You get your money immediately. Whether you choose a cash-out refinance or a home equity loan, you walk away with a lump sum cash payment as soon as you close. You can spend the money on anything you need.
- You borrow against the equity in your home. Both these loans use your home as collateral, which means you can get lower interest rates for cash-out refinances and home equity loans than other types of loans.
- You can’t take 100% equity from your home. Most lenders and loan types require that you leave some equity in the home.
Differences Between Cash-Out Refinances And Home Equity Loans
- Cash-out refinances are first loans, while home equity loans are second loans. Cash-out refinances pay off your existing mortgage and give you a new one. On the other hand, home equity loans are a separate loan from your mortgage and add a second payment.
- Cash-out refinances have better interest rates. Since cash-out refinances are first loans (meaning they’ll be paid first in the case of a bankruptcy or judgment), they typically have lower interest rates.
When A Home Equity Loan Makes Sense
If refinancing your mortgage would force you to get a significantly higher interest rate, it might make sense to look at alternatives like home equity loans. However, the higher interest rate on the home equity loan might not be worth it either. It’s important to crunch the numbers to determine if a home equity loan makes sense for you.
When A Cash-Out Refinance Makes Sense
If your home value has climbed or you’ve built up equity over time by making payments, a cash-out refinance might make sense for you.
Cash-out refinances are a very low-interest way to borrow the money you need for renovations, tuition, debt consolidation or other expenses. If you have big expenses that you need to borrow money for, a cash-out refinance can be a great way to cover those expenses while paying little in interest.
While both loan options allow you to borrow against the equity in your home and access the cash immediately, the loan type and interest rates may make one a better choice over the other for you.
Rocket Mortgage® by Quicken Loans® allows you to see how much cash you could get from your home. With the Rocket Mortgage® online process, you submit information about your home, income and assets, and we’ll give you mortgage solutions that show your cash-out options. To get started, create your Rocket Mortgage® account now.
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