Home equity loans and cash-out refinances are two ways to access the value that has accumulated in your home. Both loans have important similarities and differences.
In a nutshell, if you already have a mortgage, a home equity loan will become a second mortgage, while a cash-out refinance replaces your current mortgage with a new term, interest rate and monthly payment.
This article will give you the lowdown on exactly how each of these loans work and what you need to know to make the most of your home equity.
How home equity loans and cash-out refis are similar:
- Both usually have fixed interest rates
- Both typically require an after-transaction loan-to-value ratio of 90% or less to qualify
- Both offer lump-sum payouts
How home equity loans and cash-out refis differ:
- Adjustable rates are possible with cash-out refis
- Cash-out refis are one loan as opposed to an additional mortgage and usually have lower interest rates
- Home equity loan lenders typically pay all or most of the closing costs
Why You Might Use A Home Equity Loan or Cash-Out Refinance
You spent a ton of money to get your home and that makes it a huge investment opportunity. Every time you make a payment, you gain equity in your home. Your equity grows even faster in an environment where home values are rising, as they are now.
Home equity loans and cash-out refinances allow you to access that value, or your home equity, to unlock the true investment potential of your home. They can be used to pay off home improvements, augment a college fund, consolidate debt or give your retirement fund a boost.
If you recently purchased your home, you may not have a lot of equity to work with. However, if you’ve owned your home for five or more years and make your payments on time, you’ll likely have equity.
To find out how much equity you have, calculate the difference between what your home’s value is and how much you still owe on the mortgage. If that number is positive, you’re a candidate for a cash-out refinance or a home equity loan.
To find out which option may be best for you, learn more about the pros and cons of each below.
Home Equity Loans
A home equity loan, like a first mortgage, allows you to borrow a specific sum for a set term at a fixed or variable rate. Because of this, a home equity loan is, in reality, a second mortgage.
You can use a home equity loan to refinance your first mortgage, a current home equity loan or a home equity line of credit. If you’ve built up equity, refinancing with a home equity loan could help when rates are high.
Home Equity Loan Pros
While there may be limits set by lenders or investors regarding how much of your existing equity you can take a loan against, you have the option to go with a fixed payment. That way, your payment never changes and you know what you’re getting.
Home equity loans also give you the flexibility to hold onto the existing rate and term of your primary mortgage if you’re happy with it. Some would rather have the flexibility of paying on a separate loan rather than touch their primary mortgage.
If you’re looking to purchase a home, there is the option to take out a primary mortgage and then use a secondary mortgage to bring your total equity down to 80% and avoid paying for mortgage insurance. This may sometimes be cheaper than the mortgage insurance policy.
Be aware that if you’re going to do this, your lender may require you to make a slightly higher down payment (e.g. 10% or more) in order to have the option to take a second mortgage.
Home Equity Loan Cons
Since home equity loans are a second mortgage, you’re going to pay a higher rate than you would if it were your first mortgage because lenders assume you’re going to make payments on your primary mortgage first.
Your home equity loan lender gets a lien on your house, but the primary lender’s lien takes precedence. In exchange for the additional risk, the lender on the second mortgage will charge you more.
Additionally, home equity loans taken out to do things other than build, buy or improve your home don’t feature tax-deductible interest after the 2017 tax year.
The last downside is that you have two mortgage payments to worry about. It can complicate things.
Quicken Loans doesn’t offer home equity loans at this time.
Home Equity Loans at-a-glance:
- You can borrow 80 – 89% of your home’s value (between a first and second mortgage)
- 15-year payback
- The loan isn’t taxable, but you may be able to deduct interest
- It’s a second mortgage, which will come with a higher rate than your primary mortgage
Like home equity loans, a cash-out refinance utilizes your existing home equity and converts it into money you can use. The difference? A cash-out refinance is an entirely new primary mortgage with cash back — not a second mortgage.
With any option, the more equity you have, the more you can take and convert to cash. The exact amount will depend on the type of loan you’re using and other factors, like your credit score.
With a cash-out refinance, lenders typically limit the amount to
80% – 90% of the home’s value, leaving 10% – 20% equity. If you qualify for a VA loan, you can borrow up to 100% equity.
Cash-Out Refinance Pros
A cash-out refinance features many of the benefits of home equity loans, but with a couple of key advantages.
The first big advantage is you’ll only have one mortgage against your house. That means there’s less risk for the lender and you’ll get a better rate than you would if it were a second mortgage. This is also why a cash-out refi is typically easier to qualify for as it gives lenders first payback priority.
Another upside? Low interest rates, which is good when trying to accomplish any financial goal. And, you’ll only need to budget for one mortgage payment.
Cash-out refinances are often the best way to consolidate debt because they’re based on your primary mortgage, so you’re getting the lowest possible mortgage rate for your financial profile. Mortgage rates recently have been in the high 4% to low 5% range for a 30-year fixed.
The average credit card interest rate is currently in the high teens.
By taking cash out to pay off high-interest debt like credit card balances, you can potentially save yourself a lot of money when compared to paying off the balances incrementally over time.
Cash-Out Refinance Cons
As previously discussed, if you want to take advantage of a cash-out refinance, you usually have to leave a minimum amount of equity within the home. Because of this, it’s very important to make sure that you can take out enough home value to accomplish your goal.
If you don’t have enough equity to get the job done, you might take a look at alternatives like a second mortgage or personal loan.
Although the lowest rates for taking cash out are available to those who refinance their primary property, you may wish to take a second mortgage if you really like your primary mortgage rate and don’t want your payment to change.
Cash-out refinance at-a-glance:
- You can borrow 80 – 90% of your home’s value (up to 100% with a VA loan)
- Easy to qualify for
- Low interest
- 15 – 30 year payback
- The loan isn’t taxed, but you may be able to deduct interest
- The interest rate would be lower than a home equity loan because it’s your primary mortgage.
- You only have one mortgage payment.
Which One Is Right for Me?
Is the best option for you a home equity loan or cash-out refinance? The answer depends on your personal situation, and we absolutely recommend speaking with a financial advisor. In the meantime, here are some key points to consider.
The type of loan that’s best for you depends on several factors:
- How much equity you have
- Your mortgage interest rate
- How much you’d like to borrow
- Your ideal repayment timeline
- If you want a fixed or flexible term
A home equity loan might be good if:
- You want to access your home’s value without affecting your primary mortgage
- You’re using a second mortgage to avoid paying for mortgage insurance
- You’re using it in place of or in combination with a cash-out refinance in order to access more of your home’s value
- Today’s rates are higher than your existing mortgage’s rate
A cash-out refinance is best if:
- You have plenty of equity to accomplish your goal and you want the lowest rate
- You’re attracted to the low rate for debt consolidation purposes, home improvement or fortifying investments
- You would like to keep a single mortgage payment
If you’re ready to get started with a cash-out refi, you can apply online or give us a call at (800) 785-4788. If you still have questions, you can leave us a note in the comments below.
If you don’t want to tap into your home equity or don’t have enough built up to accomplish your financial goals, a personal loan could be a good option that might make more sense for your financial situation. Our friends at Rocket Loans® offer personal loans up to $45,000.
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