Cash-out refinance vs. home equity loans: What you need to know

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In a Nutshell

A home equity loan is a second mortgage loan that uses the equity in your home as the collateral. A cash-out refinance lets you borrow against the equity in your home by refinancing for more than you owe and giving you the difference in cash. We’ll compare the pros and cons.
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Cash-out refinances and home equity loans are two ways to tap into home equity — but is one better than the other?

If you need cash to make a large purchase, pay for home repairs or consolidate debt, a home equity loan or cash-out refinance could help you borrow money. Plus, using home equity to pay for home improvements may come with tax advantages.

We’ll explore how cash-out refinancing and home equity loans work to help you decide which may be best for you.

What is the difference between a home equity loan and a cash-out refinance?

A home equity loan, sometimes called a second mortgage, is an installment loan that’s secured by your home. The loan is separate from your first mortgage, and monthly payments are usually fixed. The amount you can borrow is typically capped at 80% to 85% of the equity you have built up.

A cash-out refinance lets you take out a new mortgage for a higher amount than what you owe. The new mortgage pays off your current mortgage, and you pocket the difference (minus any fees).

How much can you access with cash-out refinancing? It depends on factors such as your home’s value and how much equity you have. For conventional loans, you’re typically able to draw up to 80% of the value of your home. But if you have a VA loan, you may be able to draw up to 100% of your home’s value.

Here are some more differences between home equity loans and cash-out refinances.

Loan terms

When you borrow cash using a cash-out refinance, the repayment period is a new mortgage term, typically 15 to 30 years. Loan terms for a home equity loan can be as little as five years.

Interest rates

While interest rates vary depending on your credit, cash-out refinances may have lower interest rates than home equity loans. You should compare rates to see what makes the most sense for your finances.

Availability of funds

It could take several weeks to apply for and get funds from a home equity loan. Cash-out refinances can also take a month or more to process since you have to go through the steps of refinancing and closing before you get a lump sum in cash.

When to use a cash-out refinance

Refinancing to take out cash makes the most sense if you have a game plan for the money and you’re able to secure better mortgage terms than what you currently have.

Ideally, cash-out refinancing should lower your interest rate so you can access interest savings while borrowing. This way, the money you save offsets the closing costs. On the other hand, if a cash-out refinance increases your rate and monthly payments to an unmanageable level, it could put your home in jeopardy.

If convenience is high on your priority list, cash-out refinances can also be a good choice because the money you borrow is rolled into your monthly mortgage payment and you still only have to keep up with one bill.

When to use a home equity loan

If you already have a good interest rate on your mortgage, taking out a home equity loan instead of opting for a cash-out refinance could be the better move.

Home equity loan closing costs may be lower, and you could customize your home equity loan terms separately without changing your mortgage.

Things to consider when comparing a cash out-refinance vs. a home equity loan

Before tapping into your home’s equity with a home equity loan or cash-out refinance, these are important variables to consider.

  1. What are the eligibility requirements? Homeowners may need at least fair credit to qualify for a cash-out refinance or home equity loan. But having a higher credit score could land you a better rate.
  2. What loan term do you need? Both home equity loans and cash-out refinancing may offer terms of up to 30 years. But if you’re looking for a shorter loan term, a home equity loan may provide more-flexible repayment options.
  3. How much do you need to borrow? If you only need a few thousand dollars to, say, pay for a medical bill, special event or new furniture, the closing costs of the cash-out refinance could end up being higher than the amount you actually need to borrow. In this case, a home equity loan or unsecured personal loan could be more affordable ways to get cash.
  4. How long do you plan on staying in the home? The longer you live in a home, the more time you’ll have to recoup the refinancing costs with interest saved. If you have plans to move and buy a new house, a home equity loan could be a better option since the upfront costs are lower, and the loan could be paid off using cash from the deal when you find a buyer.
  5. How fast do you need cash? Cash-out refinances and home equity loans don’t offer quick money — it could take several weeks or longer to close on either type of loan. If you need fast money in your bank account for an emergency, consider the alternative of a personal loan. Some personal loan lenders may offer funding within a business day of approval, though exact timing will depend on your bank.

Next steps

If you’re considering a home equity loan or cash-out refinance, the first thing to do is calculate your home equity to see how much you may be able to borrow.

Then start shopping around with lenders to see what rates and fees they offer. In some cases, lenders offer no-closing-cost loans — but this doesn’t mean you won’t pay those costs in other ways. You might, for example, pay a higher interest rate to compensate for the lower upfront cost, so be sure to review the total cost of the mortgage when shopping around for a home loan.

About the author: Taylor Medine is a freelance writer who’s covered all things personal finance for the past seven years. She enjoys writing financial product reviews and guides on budgeting, saving, repaying debt and building credit. … Read more.