Do you need extra money to help pay for home improvements, debt consolidation, or unexpected car repairs? Consider tapping into your home’s equity through a cash out refinance or home equity loan.
Both loan options allow homeowners to access their home’s equity to finance a variety of things, but you need to compare cash-out refinance vs. home equity loan to decide what’s best for you.
What Is a Home Equity Loan?
Home equity loans offer homeowners a way to borrow money against the amount of equity in their homes. Home equity is the difference between what you owe on your mortgage and the home’s current market value. Home equity loans are also called second mortgages because they’re a separate loan payment in addition to your mortgage.
Because your home also serves as collateral for the loan, failure to make payments could lead to foreclosure. Since homeowners take on more risk with a home equity loan, lenders typically offer lower interest rates than they would for an unsecured loan.
How Does a Home Equity Loan Work?
When you take out a home equity loan, the lender will approve the loan amount based on the percentage of equity that you have in your home.
The lender may allow you to borrow 80% to 85% of your home’s value, minus what you owe on the mortgage. Other requirements for a home equity loan include having a good credit score, a low debt-to-income ratio, and a steady source of income.
Once approved for the loan, your lender will provide loan disclosures stating the amount you’re borrowing, your interest rate, and any fees that you must pay. Common fees in closing costs include an origination fee, appraisal fee, document preparation fees, broker fees, and application fees. Some lenders may reduce or waive these fees altogether.
A home equity loan is paid out in a lump sum and tends to be fixed-rate. You’ll need to repay the loan in fixed monthly installments that include the principal and interest. Repayment periods vary but are usually between five and thirty years.
Looking to take out a home equity loan? Find a Total Mortgage branch nearest to you and chat with one of our mortgage specialists to discuss your options.
What Is a Cash Out Refinance?
A cash out refinance is another way to take advantage of the built-up equity in your home. A cash out refinance allows homeowners to take out a new mortgage, up to 80% of the value of the home, for more than what is owed on the house.
This new mortgage pays off the old mortgage and the difference between the two, minus closing costs, is paid out in cash. This new loan is larger and may come with different terms.
How Does a Cash Out Refinance Work?
A cash out refinance is similar to a traditional refinance. You can shop different lenders and compare quotes, submit an application and required documentation, get approval, and wait for your payment.
You’ll also need to meet basic requirements for a cash out refinance, but these vary by lender.
Common requirements include:
- Have a credit score of at least 620
- A debt-to-income ratio of 43% or less
- At least 20% equity in your home
To illustrate, let’s say you have a mortgage balance of $125,000 and the market value of your home is $300,000.
If you’re borrowing 80% of your home’s value, you’d be able to take out $115,000 for a loan balance of $240,000. This means you have $115,000 to use on almost anything you please, whether that’s a vacation, a wedding, or your education.
Cash Out Refinance vs. Home Equity Loan Similarities
When comparing a cash out refinance and a home equity loan, both options allow homeowners to borrow money against the amount of equity in their homes. No matter which option you choose, both pay almost immediately and you can use that money to pay for anything you need.
A cash out refinance and home equity loan also have similar borrowing requirements. If you’re eligible for a home equity loan, you’re more than likely eligible for a cash out refinance as well. However, this also varies by lender.
Both options also allow you to borrow the same amount — up to 80% of the current value of your home.
Cash Out Refinance vs Home Equity Loan Differences
Cash out refinance payments are often easier to manage because they replace your existing home loan. Home equity loans are another monthly loan payment along with your mortgage payment.
A cash out refinance may also come with lower interest rates because they’re considered first-lien debt, which is paid out first to debt holders in the event of a foreclosure or bankruptcy. However, the higher interest rate on a home equity loan may be offset by low or no closing costs.
Which Is the Smarter Option? Cash Out Refinance or Home Equity Loan
If you’re deciding between a cash out refinance vs home equity loan, a cash out refinance might make more sense if you’re eligible for a lower interest rate. But if you plan to take out a larger portion of equity or cannot find a lower interest rate when refinancing, a home equity loan may be worth considering.
What you choose may also depend on the amount of equity you’ve built in your home, your creditworthiness, and lenders’ current offers. Both options have their own benefits and drawbacks, which is why it’s essential that homeowners do their homework to learn which option is best for their situation.
Learn More About Your Options With Total Mortgage
Luckily, homeowners have options when it comes to unlocking their home equity. If you’re deciding between a cash out refinance vs. home equity loan, Total Mortgage has you covered.