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If you want a cash infusion, whether it’s to make home improvements, pay off debt, or start a business, you can tap into your home’s equity. Currently, the number of homes in the United States with at least 50% equity is the highest in four years, according to ATTOM, a real estate data company.
You can access your home’s equity with a home equity loan or refinancing. There are key differences between these products that you should consider before choosing one.
What is a home equity loan?
Your home’s equity is the current market value of your home minus what you owe on your mortgage loan. A home equity loan is a loan homeowners can take out using their home as collateral. Sometimes, consumers use the terms home equity loan and home equity line of credit (HELOC) interchangeably, but they are different products.
With a home equity loan, lenders typically allow you to borrow up to 80% of the equity in your home. The benefit of a home equity loan is you get a set amount of money with straightforward repayment terms over a certain period. The downside of a home equity loan is your home is the collateral for the loan, meaning if you can’t repay the loan, your lender could foreclose on your home.
You can use your home equity loan for any expense, whether you want to start a business or consolidate debt. However, remember that because you are using your home as collateral, it’s essential to use your funds wisely. You can also consider other lending options, like a personal loan, prior to applying for a home equity loan.
What is a cash-out refinance?
A cash-out refinance is another strategy you can use to access the equity in your home. It operates just like it sounds: homeowners can re-apply for a new, larger mortgage and take out equity in the form of cash.
Cash-out refinancing is different from a home equity loan. With a home equity loan, you keep your current mortgage loan and borrow against the equity in your home. With a cash-out finance, you get an entirely new mortgage.
When getting a cash-out refinance, a lender will assess the value of your home through the appraisal process. If your property has significantly increased in value, you can elect to get a new mortgage loan for that amount.
When you get a new mortgage, it pays off your existing mortgage. If your new mortgage is for a larger amount than your old one, you get the difference in a lump sum, minus any lender and real estate fees.
Remember, when you get a cash-out refinance, you get an entirely new mortgage. So, if you paid on your old 30-year mortgage for seven years and then got a new 30-year mortgage, keep in mind your mortgage will “reset.”
You can use the funds from your cash out refinance for anything because it is not a loan with specific requirements, like an auto loan. For example, you can use the money for credit card debt repayment, home improvements, education costs, business start-up costs, or to keep in cash reserves.
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Home equity loan vs refinance: similarities
There are several similarities between a home equity loan and a cash-out refinance. Here are some examples.
Funding time
Both home equity loans and cash out refinances take a similar amount of time to fund. It can take a couple of weeks to apply for these lending options, have a lender verify your information, and receive your money. The process will include filling out forms, going through a credit check, and other steps.
Appraisals
Whether you’re taking out a home equity loan or refinancing, you will go through the home appraisal process to see what your house is worth.
Both utilize equity
Homeowners can access their home equity using both of these lending options. A home equity loan allows homeowners to borrow against their existing equity. A refinance enables borrowers to withdraw their equity while getting a new mortgage loan.
Both have specific qualifications
Not every homeowner will be eligible to access their equity. Both home equity loans and refinance loans require buyers to meet specific qualifications, which will vary depending on the lender. You may have to meet income criteria, have a specific credit score, and more. Generally, lenders prefer a credit score of 620 or above for a mortgage refinance and 680 or above for a home equity loan.
Cash out refinance vs home equity loan: differences
There are some key differences between these two lending products homeowners should be aware of before deciding which is best.
One monthly payment vs. two monthly payments
Another name for a home equity loan is a second mortgage. So, you’ll be responsible for your mortgage payment and your loan payment every month. If you want to sell your home, you must pay the remainder of both your first and second mortgage before you can take any proceeds.
With a home refinance, you will only have one payment. The term for your mortgage, whether it's a 15-year mortgage or a 30-year mortgage, starts over with your new loan.
Interest rates
If you want a home equity loan, they typically come with a fixed rate. You'll have specific repayment terms and set monthly payments.
There are several mortgage loan options. You can choose one with a fixed rate and set payments, but there are also adjustable rate mortgages. Additionally, you are not guaranteed to get the same interest rate as your first mortgage. If mortgage rates have gone up considerably since you bought your house or did a rate refinance, you may have to pay higher interest rates after refinancing.
Loan requirements
A home equity loan and a loan refinance might have different loan requirements. Depending on the lender, you might have to have a certain income, equity percentage, or credit requirements.
A home equity loan typically requires a higher credit score than a refinance, but a refinance might have more steps since you are taking out a completely new mortgage.
Product costs
Both home equity loans and mortgage refinance loans come with closing costs, but the types of fees might be different.
A home equity loan will have application fees, appraisal fees, title fees, interest costs, and other potential lender fees. Home refinancing also has appraisal fees, title fees, and interest costs, but they also have origination fees.
It is possible to get a no fee home equity loan and a no fee refinance, but sometimes this results in a higher APR.
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Choosing between home equity loan vs cash out refinance
Many homeowners utilize both of these financial products each year, but the best one for you depends on your needs and financial circumstances.
When is a home equity loan a good idea?
A home equity loan is a good idea if you currently have a low interest rate on your mortgage, meet the credit requirements, and have enough equity in your home to qualify. It's also a good idea if you want to avoid going through the process of refinancing your mortgage.
Homeowners should be well aware of the risks of a home equity loan and be prepared to make their loan payments on time.
When is a cash-out refinance a good idea?
A cash out refinance is a good idea in a couple of situations. First of all, if the interest rate climate changes and you can get a lower mortgage rate, a cash out refinance might be a better long-term option.
Additionally, you may be able to access more money by opting for a cash out refinance, since home equity loans typically have a cap on how much you can borrow.
Like home equity loans, borrowers should only apply for one if they’re able to make their payments on time, especially if their new mortgage comes with larger payments.
The bottom line
Ultimately, whether a cash out refinance or a home equity loan is better for you will depend on your personal situation, the value of your home, the amount of equity you have in your home, and your financial goals.
Your loan, interest rates, and repayment periods might vary depending on which lending product you choose. However both provide an opportunity for homeowners to use their equity in a way that serves them best.
If neither of these options is a good fit for you, check out the Home Equity Investment (HEI), which enables you to tap into your home’s equity with no monthly payments.
