The Difference Between Cash-Out Refinances And Home Equity Loans

Your home is an investment, and the equity in your home is something you can use to reach your financial goals. You can use a cash-out refinance or home equity loan to access the cash in your home to renovate your property, pay for college expenses, or consolidate debt. Let’s look at the differences between cash-out refinances and home equity loans so you can pick the loan option that’s right for you.

What Is A Cash-Out Refinance?

A cash-out refinance replaces your existing mortgage with a new one that is more than what you currently owe. This allows you to pocket a portion of the equity you have.

You can use a cash-out refinance if you’ve had your mortgage loan long enough to build enough equity in the home. Most homeowners choose cash-out refinancing when the value of their home climbs. If you suspect your home value has risen since you bought it and need a large sum of cash, consider a cash-out refinance to tap into your home equity.

How A Cash-Out Refinance Works

A cash-out refinance involves taking out a new and bigger loan to replace your existing mortgage. You use the new mortgage to pay off your original mortgage, then pocket the difference between your new loan amount and your original mortgage loan balance as cash – minus any equity left in your home, closing costs, and fees.

Here’s an example: Your home is worth $200,000, and you owe $100,000 on your mortgage. You usually must leave 20% equity (in this case, $40,000) in the home after closing. If you refinance your home with a $160,000 loan, you’ll pocket $60,000, minus remaining equity, closing costs, and fees.

Your monthly payments will likely increase since the new loan amount is larger. Use our refinance calculator to estimate your new monthly payments.

How Much Equity Can You Cash Out Of Your Home?

Homeowners typically can’t get a loan for the entire value of their home. Many loan types require that you leave some equity behind in the home.

For conventional and Federal Housing Administration (FHA) loans, you must leave 20% equity in your home after the cash-out refinance. Department of Veterans Affairs (VA) loans are an exception. You can get a cash-out loan for 100% of your home’s value.

Using Your Cash-Out Refinance Funds

The funds from a cash-out refinance are tax-free and can be used in any way you like. Most homeowners use the money for renovations, but you can use it however you see fit.

What Is A Home Equity Loan?

A home equity loan also allows you to borrow against the equity in your home. It’s a second loan that’s separate from your original mortgage.

Unlike a cash-out refinance, a home equity loan won’t replace your mortgage. It’s a second mortgage secured by your home with a separate payment. Because it’s a second loan, home equity loans typically have higher interest rates than first mortgages.

HomeLoansByAli® is now offering Home Equity Loans, which are available for primary and secondary homes.

How A Home Equity Loan Works

Since a home equity loan is separate from your original mortgage, the loan terms on your original mortgage stay the same. After the home equity loan closes, you’ll receive a lump-sum payment from your lender, which you’ll repay in monthly installments – usually at a fixed rate.

What Are The Similarities Between Cash-Out Refinances And Home Equity Loans?

Cash-out refinances and home equity loans share similarities that make both options appealing to homeowners.

• You get your money quickly. You can walk away with a lump-sum cash payment up to 3 business days after closing. The waiting period gives borrowers time to exercise their right of rescission, which allows them to cancel if they change their minds.
• Your home is the security for the loan. Your home serves as collateral for both loans. Since the loans are secured, you’ll likely get lower interest rates than you would with unsecured loans.
• You typically can’t access 100% of your home’s equity. Most lenders and loan types require borrowers to leave some equity in the home.

What Are The Differences Between Home Equity Loans And Refinances?

While home equity and cash-out refinance loans share similarities, they have key differences.

• 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, while a home equity loan is a separate loan that’s considered a second mortgage.
• 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 foreclosure, bankruptcy, or judgment – they typically have lower interest rates.

When A Home Equity Loan Makes Sense

Home equity loans can be a good choice for borrowers looking for money to cover renovations, big purchases like a car, or a down payment on an investment property. These types of loans allow you to maintain your current interest rate on your original loan while taking out a new loan that you can pay down separately.

If you’re unsure how much cash you need or don’t need all at once, consider looking into a home equity line of credit (HELOC) to determine whether a HELOC or cash-out refinance makes more sense. HomeLoansByAli does not offer HELOCs at this time.

When A Cash-Out Refinance Makes Sense

If your home’s value has increased or you’ve built up equity over time through mortgage payments, a cash-out refinance may be the right option.

Cash-out refinancing is a potentially low-interest way to borrow money for expenses such as home improvements or school tuition or to consolidate debt. If you have major expenses coming up, a cash-out refinance can be a great way to cover them while paying less interest compared to other options.

FAQs For Home Equity Loan Vs. Refinance

Now, let’s answer some frequently asked questions about home equity loans versus cash-out refinances.

Can you refinance your home equity loan?

Yes, you can refinance your home equity loan. Refinancing is typically a good idea when loan interest rates are lower than when you took out the original loan or you want to switch between an adjustable- and a fixed-rate loan.

Is a home equity loan cheaper than a refinance?

Home equity loans (and home equity lines of credit) typically have significantly lower closing costs than cash-out refinances. Sometimes, the lender will even absorb closing costs, too.

While home equity loans and HELOCs typically have higher interest rates, they may be a better option than a cash-out refinance if their rates are comparable to your current mortgage rate, especially if you’re only borrowing a small amount of money.

What are the alternatives to a HELOC or cash-out refinance?

If you’re considering refinancing to cover a small project or pay off a small debt, a personal loan or credit card with a low interest rate may be a better option. With either option, you can avoid the closing costs associated with cash-out refinances, home equity loans, and HELOCs.

Will I lose my home equity when I refinance?

In short, no. You won’t lose equity when you refinance your home, though you may decrease it. Your home equity will fluctuate based on how much of your mortgage you’ve paid off and the impact of market shifts on your home’s value. Tapping into your home equity to make improvements or fund renovation projects can also potentially increase your home’s value and, with it, the equity.

The Bottom Line

While cash-out refinances and home equity loans allow you to borrow against the equity in your home and access the cash immediately, the way the loans are structured and their potential interest rates may make one option the better choice for you.