Cash-Out Refinance vs. Home Equity Loan: What’s the Difference?

If you’re a homeowner, you may have considered tapping into your home’s equity to secure a loan.

Two common options homeowners use to turn equity into funds are a cash-out refinance or a Home Equity Loan. This blog breaks down both options to help you determine which is right for you.

What is a cash-out refinance?

A cash-out refinance is a specific form of mortgage refinance where a new mortgage loan replaces the existing one for a larger sum than previously owed. The borrower then receives cash for the additional mortgaged amount.

Here’s an example. Let’s say you purchased a house for $250,000. You’ve since paid off $50,000, meaning you have a $200,000 mortgage and $50,000 in home equity. Now, you want to do a kitchen renovation that will cost $20,000.

If you used a cash-out refinance, you could take out a new mortgage for $220,000, use that to pay off the existing $200,000 mortgage, and receive the $20,000 difference in cash a few days after closing.

What to consider before a cash-out refinance

A cash-out refinance can give you a decent sum of cash at a comparatively low interest rate (although the rate will probably be 1 – 2% higher than the first mortgage rate). It can be a smart borrowing option with a variety of uses, such as home repairs, renovations, debt consolidation, and more.

Before you apply, there are several factors to consider. First, your new mortgage will have new terms. Depending on the rate at which you financed your existing mortgage, you’ll need to crunch the numbers to make sure the new terms make financial sense.

In other words, moving forward with a cash-out refinance may not make sense if it means you’ll have a higher interest rate on your new loan.

Additionally, a cash-out refinance only works if you have equity in your home. Unless you have a qualifying home loan through the VA, you’ll generally only be allowed to cash out 80% of the equity you’ve accrued.

Remember that, like any new mortgage, cash-out refinances require a full home appraisal (which comes with associated costs), and it can take anywhere from 30 to 60 days for the process to be completed. You will usually pay closing costs of 1 – 2% of the home’s value.

What is a Home Equity Loan?

As discussed, when you opt for a cash-out refinance, you replace your existing mortgage with a new one. In contrast, a Home Equity Loan allows you to borrow against your equity in the form of a second loan. You’ll receive the loan as a lump sum with a fixed interest rate, which you’ll pay back in installments over several years.

In other words, your existing mortgage terms don’t change when you use a Home Equity Loan. You are instead taking out a second loan.

Although their uses are flexible, most borrowers use a Home Equity Loan for renovations, repairs, or debt consolidation.

Like a cash-out refinance, you can only take a Home Equity Loan if you have equity against which to borrow. You generally need to have at least 20% equity in your home to be considered for this loan option.

What to consider before taking a Home Equity Loan

In general, Home Equity Loans are a smart, low-interest borrowing option. You can use the borrowed money for almost anything, and the interest rates are low compared to many other lending options. The interest rate on a Home Equity Loan is fixed, so you know your monthly payment won’t change.

Home Equity Loans are also easier to acquire than other traditional loans because your house is used as collateral. Since you won’t be changing your existing mortgage, Home Equity Loans can be a better option if the mortgage rates are higher than when you last financed.

Unlike a cash-out refinance, Home Equity Loans through Connexus often don’t require a full appraisal; they only need an online valuation. There may be closing costs; however, 80% of Connexus members who used a Home Equity Loan had closing costs that totaled $600 or less.

Connexus Home Equity Loans are also a quicker option than cash-out refinances, taking only 10-15 days to close once the lender has received all the paperwork.

Like any loan, do the math before applying to make sure that you can comfortably afford the repayment schedule. This is an especially important consideration with a Home Equity product because your home serves as your collateral.

How to get started

If you’re looking to use your home’s equity to secure a loan, Connexus has a variety of options available. Whichever option you choose, you can count on our competitive rates and superior, personalized service.

Give us a call today to get your home equity borrowing questions answered. If you’re ready, you can apply online for a Home Equity Loan or a cash-out refinance and start putting your equity to work.