Cash-Out Refinance And Home Equity Loan

Cash-out refinance and home equity loans are two options for homeowners to access the equity in their homes. While both involve borrowing against home equity, they differ in terms of loan structure and repayment.

A cash-out refinance replaces your existing mortgage with a new loan that is higher than your current mortgage balance. The difference between the new loan amount and the outstanding mortgage balance is paid out in cash.

Which you can use for any purpose, such as home improvements, debt consolidation, or a big expense. In contrast, a home equity loan is a second mortgage that allows you to borrow against your home equity in a lump sum and is repaid over a fixed term with a fixed interest rate.

What Is A Cash-Out Refinance?

A cash-out refinance is a type of mortgage refinancing where you replace your existing mortgage with a new one that has a higher loan amount than your current balance. The difference between the new loan amount and your old mortgage balance is paid out to you in cash at closing.

This allows you to tap into the equity you have built in your home and use the funds for various purposes such as home renovations, debt consolidation, or other financial needs. The new loan typically comes with a new interest rate and repayment terms.

Example of Cash-Out Refinance

Let’s say you purchased a home several years ago for $300,000, and you currently owe $200,000 on your mortgage. Over time, your property value has increased, and it’s now appraised at $400,000. With a cash-out refinance, you decide to refinance your mortgage for $300,000.

After paying off your existing mortgage balance of $200,000, you have an additional $100,000 ($300,000 – $200,000) available as cash. This amount can be used for various purposes, such as home renovations, paying off high-interest debts, or covering a major expense.

What Is A Home Equity Loan?

A home equity loan, also known as a second mortgage, is a type of loan that allows homeowners to borrow against the equity they have built in their homes. Equity is the difference between the current market value of the home and the outstanding balance on the mortgage.

With a home equity loan, you receive a lump sum of money based on the equity in your home. The loan amount, interest rate, and repayment terms are typically fixed. You can use the funds from a home equity loan for various purposes, such as home improvements, debt consolidation, education expenses, or other financial needs.

Example of Home Equity Loan

Let’s say your home appraisal value is at $400,000, and you currently have a mortgage balance of $250,000. The difference between the appraised value and the outstanding mortgage balance is your home equity, which in this case is $150,000 ($400,000 – $250,000).

You decide to apply for a home equity loan with a lender that offers a maximum loan-to-value (LTV) ratio of 80%. Based on this LTV ratio, you can borrow up to 80% of your home’s appraised value, which would be $320,000 ($400,000 x 80%).

However, since you still have an existing mortgage balance of $250,000, you would subtract that from the maximum amount. In this case, the maximum home equity loan amount you could receive is $70,000 ($320,000 – $250,000).

» Check Your Home Equity: Estimate your home’s current market value with free home value estimator. Subtract any outstanding mortgage balance and see how much equity you’ve built.

Common Factors of Cash-Out Refinance and Home Equity

While cash-out refinancing and home equity loans have differences, there are also common factors between the two:

• Use of Home Equity: Both cash-out refinancing and home equity loans allow homeowners to access the equity in their homes.
• Tapping into Cash: Both options provide homeowners with a lump sum of money that they can use for various purposes, such as home improvements, debt consolidation, education expenses, or other financial needs.
• Secured by Home: Both cash-out refinancing and home equity loans are secured by the property itself.
• Interest Deductibility: In many cases, the interest paid on both cash-out refinancing and home equity loans may be tax-deductible, subject to certain limitations and tax regulations.
• Eligibility Criteria: Both options typically require homeowners to meet certain eligibility criteria, including factors like creditworthiness, income, and loan-to-value (LTV) ratio.

Home Equity Loans Vs. Cash-Out Refinances

Home Equity Loans and Cash-Out Refinances are two options for homeowners to access their home equity, but they differ in several key aspects:

• Loan Structure: A home equity loan is a separate loan in addition to your existing mortgage. While a cash-out refinance replaces your current mortgage with a new, larger loan.
• Loan Amount: With a home equity loan, you receive a lump sum based on the equity in your home. While a cash-out refinance allows you to borrow a larger amount by refinancing your entire mortgage.
• Interest Rates: Home equity loans usually have fixed interest rates. While cash-out refinances may have either fixed or adjustable rates.
• Repayment Terms: Home equity loans typically have fixed repayment terms and monthly payments. While cash-out refinances come with new mortgage terms, which can include a different interest rate, loan term, and monthly payment.
• Closing Costs: Both options involve closing costs, but cash-out refinances tend to have higher closing costs.
• Mortgage Interest Deduction: Both may allow you to deduct mortgage interest payments. But there are specific limitations and tax rules that apply.

Home Equity Loan – When to Choose One?

A home equity loan may be a good choice when you want a lump sum of money for a specific purpose, such as a home renovation project or consolidating high-interest debts.

It can be advantageous if you prefer a fixed interest rate, predictable monthly payments, and keeping your existing mortgage terms unchanged.

Cash Out Refinance – When to Choose One?

A cash-out refinance is a suitable choice when you want to access a larger amount of funds and are willing to refinance your entire mortgage.

It can be beneficial if you want to take advantage of lower interest rates, change loan terms, consolidate debts, or make significant investments or purchases.

Final Thoughts

Both home equity loans and cash-out refinances offer homeowners the opportunity to access their home equity. Home equity loans provide a lump sum with fixed rates and repayment terms.

While cash-out refinances replace the existing mortgage with a new loan, offering potentially lower rates and flexibility. Choosing between the two depends on your specific financial needs and preferences.

It’s important to evaluate the costs, terms, and benefits of each option before making a decision.

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