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

When you need extra cash, your home can be a valuable resource. There are two common options for accessing your home’s equity: cash-out mortgage refinancing and home equity loans. Although both options allow you to borrow against your home’s value, they work differently and are suited to different financial needs. Here’s a breakdown of how each option works and when one might be better than the other.

What is Cash-Out Mortgage Refinancing?

Cash-out refinancing involves replacing your existing mortgage with a new, larger mortgage. The difference between your new loan and what you owe on your current mortgage is paid out to you in cash. This option allows you to refinance your mortgage at a potentially lower interest rate while also providing you with a lump sum of money.

How It Works:

1. You take out a new mortgage for more than you currently owe.
2. The new mortgage pays off your existing mortgage.
3. You receive the difference between the new loan amount and the remaining balance on your old mortgage as cash.

Pros:

• Potentially lower interest rates compared to other forms of borrowing.
• You can use the cash for any purpose, such as home improvements, debt consolidation, or major purchases.
• Simplifies payments by consolidating your mortgage and cash-out amount into a single loan.

Cons:

• Extends the term of your mortgage, meaning you might end up paying more in interest over time.
• Increases your mortgage balance, which could be risky if home values decline.
• Closing costs can be higher than other options, which might offset some of the financial benefits.

When to Choose Cash-Out Refinancing

Cash-out refinancing might be the right choice if:

• You can secure a significantly lower interest rate on your new mortgage compared to your current one.
• You plan to stay in your home long enough to benefit from the lower interest rate and closing costs.
• You want to simplify your finances by consolidating your mortgage and cash-out amount into one loan.

What is a Home Equity Loan?

A home equity loan allows you to borrow a lump sum of money using your home’s equity as collateral, without altering your existing mortgage. It’s often referred to as a second mortgage because you’re taking out an additional loan on top of your existing mortgage.

How It Works:

1. You borrow a fixed amount based on your home’s equity.
2. You receive the loan as a lump sum and repay it over a fixed term with fixed monthly payments.

Pros:

• Fixed interest rates make it easier to budget your monthly payments.
• You keep your existing mortgage unchanged, which can be beneficial if it has favorable terms.
• Ideal for specific needs, such as funding home renovations or paying off high-interest debt.

Cons:

• Adds a second monthly payment on top of your existing mortgage.
• If you can’t make the payments, you risk foreclosure on your home.
• Interest rates may be higher than cash-out refinancing rates.

When to Choose a Home Equity Loan

A home equity loan could be the better option if:

• You’re satisfied with your current mortgage terms and don’t want to change them.
• You need a specific amount of money for a targeted purpose, such as a home renovation or debt consolidation.
• You prefer the stability of fixed monthly payments with a fixed interest rate.

Understanding the differences between cash-out mortgage refinancing and home equity loans can help you make an informed decision based on your financial goals and circumstances. Whether you’re looking to lower your interest rate, access cash for a major expense, or change the terms of your current mortgage, choosing the right option will ensure you’re making the best use of your home’s equity. Before making a decision, consider consulting with one of our mortgage loan originators to explore which option best suits your needs.