Cash-Out Refi or Home Equity Loan? Which is Right for You?

Key Takeaways

• If you want to keep the interest rate and terms of your existing mortgage, you may want to consider a home equity loan as opposed to refinancing. 
• A cash-out refinance replaces your existing mortgage with a new mortgage while refunding the difference in cash. The terms will likely be different from your existing mortgage.
• If you’re looking at total costs, a home equity loan that’s paid off sooner than a full 30-year mortgage may save you money.

Cash-Out Refinance vs. Home Equity Loan – What’s the Difference?

Cash-Out Refinance vs. Home Equity Loan — What’s the Difference?

A home equity loan and cash-out refinancing are both ways to tap your home’s equity, but they involve different processes and offer different benefits. A cash-out refinances replaces your mortgage but typically offers a lower interest rate and a single monthly payment. A home equity loan is more like a traditional loan, except it uses your home as collateral. A home equity loan may be paid off sooner and cost less overall since the term is typically shorter than a traditional mortgage.

We’ll go over a cash-out refinance vs. home equity loan, when each makes sense, and what alternatives you have.

What is a Home Equity Loan

A home equity loan allows you to borrow money against the equity you have built in your home. It’s a loan that is separate from your mortgage, so if you have a great interest rate you want to keep with your existing mortgage, a home equity loan won’t change that. Instead, a home equity loan is essentially a second mortgage that adds a monthly payment on top of your primary mortgage.

What is a Cash-Out Refinance

A cash-out refinance, commonly referred to as a cash-out refi, replaces your old mortgage with a new, larger mortgage and refunds the excess equity to you in cash. Your new mortgage will have a new rate, a new term, and a new monthly payment. A major benefit of a cash-out refinance versus a home equity loan is a single mortgage payment, rather than having a loan payment on top of your regular mortgage payment.

Key Differences between a Cash-out refi and a home equity loan

This chart breaks down the differences between a cash-out refinance and a home equity loan to help you decide which would better suit your situation.

When to Choose a Home Equity Loan

There are some scenarios where a home equity loan could make more sense than a cash-out refinance.

• You want to keep your original mortgage rate. If you have a low mortgage rate, it won’t change if you get a home equity loan. Most experts advise against refinancing unless you can lower your rate. Even a small rate increase will mean higher monthly payments and adding thousands more in interest to your loan.
  
• You want to pay less in upfront costs and spend less time applying. Closing costs for a home equity loan versus a mortgage refinance tend to be lower. Some lenders might even be willing to waive closing costs. Because the underwriting requirements for a home equity loan are less extensive, the process can often be faster, with some lenders providing funding in less than a month.
  
• You want it paid off faster. With a home equity loan, you’ll choose a repayment term between 5 and 30 years (most are under 20). You’ll also be dealing with a smaller balance than what you likely have left on your mortgage. You can also consider paying off your loan early if your lender doesn’t impose pre-payment penalties.

When to Choose a Cash-Out Refinance

There are also scenarios where a cash-out refinance could make more sense than a home equity loan.

• You like the convenience of one payment. Many homeowners like having one payment and want to avoid adding another debt to their monthly obligations.
  
• You’re able to lower your interest rate. If your mortgage has a
  higher interest rate and you’re able to qualify for a lower rate, you may be able to get better terms with a new mortgage.
  
• You want to change the terms of your mortgage. Many homeowners choose to refinance when they want to change the terms of their loan. Replacing a 30-year mortgage with a 15-year mortgage may offer long-term savings.
  
  

Cash-Out Refi vs. Home Equity Loan – When it’s a Toss-up.

You want alower monthly payment. There are scenarios where either a cash-out refi or a home equity loan could result in a lower monthly cost. The main factors that determine whether you’ll get a lower payment depend on your current mortgage interest rate and term, the current interest rate environment, and what you qualify for.

Be sure to compare costs carefully or consult a financial advisor before you make a decision.

Are There Alternatives to Loans or Refinancing?

If a home equity loan or a cash-out refi won’t work for you, there are some alternatives you may want to consider.

HELOC

A home equity line of credit (HELOC) is like a home equity loan in that it is a separate loan that uses your home’s equity to underwrite the loan. However, a HELOC is an ongoing loan that you can borrow from at will, and has a more flexible repayment schedule.

HEA

A home equity agreement (HEA) is a flexible home equity financing solution, allowing homeowners to trade a portion of their home’s future equity for a lump sum of cash. HEAs or home equity investments, as they also known, offer flexible income and credit requirements and don’t require monthly payments. Homeowners typically settle the agreement when they sell their home or anytime. They can also settle anytime during their term (which typically ranges from 10 to 30 years), using cash on hand or funding from a new loan.  

Personal loan

A personal loan is a simple installment loan that doesn’t use your home equity as collateral. Your personal financial qualifications are the only factor used in the approval process. It usually comes with a higher interest rate, but it carries less risk because if you default on the loan, you’re not going to lose your house.

Conclusion

Both home equity loans and cash-out refinancing serve a purpose, and the best one depends on your situation. Home equity loans are great for homeowners who want to keep their existing mortgages with low interest rates, while cash-out refinances are great for homeowners who can get better terms with the convenience of one payment. If neither of those works for you, there are alternatives to consider.