When you have a home that has accumulated equity, you have the option to borrow against it using several financing options. Two popular ways to gain access to the equity in your home are the home equity loan, and the cash-out refinance mortgage.
Both allow you to receive a lump sum of money to use as you wish, but their structure is entirely different. When trying to decide between a home equity loan vs. refinance, it’s essential to understand the difference in how they work and what scenario(s) each option would best suit your financial needs.
What is a Home Equity Loan?
A home equity loan is a second mortgage that you take out when you want to borrow against the equity in your home. While your first mortgage purchased your property, a home equity loan is solely designed to let you borrow against the equity you’ve accumulated.
To calculate your equity, you subtract your mortgage balance from the value of your home. For example, if your home has a value of $250,000 and the mortgage balance is $200,000, you have $50,000 in equity. In this situation, you would have up to $50,000 that you can borrow via a home equity loan.
What is a Cash-Out Refinance?
A cash-out refinance is a type of mortgage refinancing that enables you to receive a lump sum at closing, which is the amount you borrow against your home equity. Unlike a home equity loan, it is not a second mortgage on your property. Your cash-out refinance loan amount will be for more than you currently owe on your home.
The difference between your current mortgage balance and the amount of your cash-out refinance loan will be the amount that you can borrow or cash out, hence the name.
You must have equity in your home to secure a cash-out refinance.
For example, if your home has a value of $250,000 and a mortgage balance of $200,000, you have $50,000 in equity. You can get a cash-out refinance loan for $225,000, which is higher than your mortgage balance. At closing, you’d receive $25,000 in cash.
Cash-out refinancing is different from traditional refinancing in that traditional refinancing replaces your current loan with one for the same amount.
The Difference Between a Home Equity Loan vs. Refinance
Both a home equity and a cash-out refinance allow you to borrow against the equity in your home. So what are the differences between the two?
The primary difference is that with a home equity loan, you are securing a second mortgage and taking that full amount in cash.
However, with a cash-out refinance, you are refinancing your original mortgage for an amount greater than what you owe and getting the difference in cash.
So, when you get a home equity loan, you will have two mortgages against your property. When you go through the cash-out refinance option, you will only have one mortgage – your original mortgage will no longer be valid.
Another difference you can expect, but that isn’t always the case, is that you pay less in interest for a cash-out refinance vs. a home equity loan.
This is because you’re refinancing your home loan instead of getting a second mortgage on your property. Since you’re refinancing your entire loan, you might be able to secure a lower interest rate for your mortgage than you did when you initially purchased your home.
A cash-out refinance has loan terms similar to a traditional mortgage, 15 to 30 years or longer. However, a home equity loan term is usually for a shorter period, up to 15 years.
How to Decide Between a Home Equity Loan vs. Refinance
Both a home equity loan and a cash-out refinance are appealing options, but there are some cases when getting one is preferential to the other. Here are a few scenarios where there’s a clear benefit to getting a home equity loan, or a cash-out refinance.
If you find yourself with better credit than when you initially secured your mortgage, and you qualify for a lower interest rate, you might want to consider a cash-out refinance to reduce how much you’re paying on your mortgage balance.
You won’t reap the same benefit with a home equity loan because your original mortgage isn’t touched, you’re just getting an additional loan secured by your property.
If, on the other hand, you have a lower credit score than when you initially borrowed or if interest rates have increased overall, it’d be better to get a home equity loan, so your original mortgage terms aren’t adjusted.
How Long You’ll Remain In Your Home
If you’re planning to sell your home within 12 months of borrowing against your equity, you’ll probably do best with a home equity loan.
One of the benefits of a cash-out refinance is that you can potentially secure a lower interest rate for your mortgage, which would reduce how much you pay. If you plan to sell your home soon after obtaining the loan, you won’t see those benefits, so it might not be worth it.
Is a Home Equity Loan or Cash-Out Refinance For You?
Ultimately, to decide whether a home equity loan vs. refinance is right for you, you want to review your current finances and your plans for your home.
It’s best to speak with an experienced loan officer who can provide personalized financial recommendations to meet your goals.
At GHS Federal Credit Union, we have staff on hand to help you make the best decision. If you’re leaning toward getting a home equity loan, we offer same day pre-qualification and fast closing to get you the money you need quickly.
Click the link below to learn more about our home equity loan options.