Cash refinances are the first loans, while home-equity loans are second loans. Cashout refinances pay off your current mortgage and give you a new one. A cash-out refinance pays off your old mortgage in exchange for a new mortgage, ideally at a lower interest rate. A home equity loan gives you cash in exchange for the equity you have accumulated on your property, such as a separate loan with different payment dates.
The biggest similarity between the two options is that both allow the homeowner to access the equity they have accumulated in their home, either through regular mortgage payments or through an increase in the value of their home. Homeowners who have at least 20 percent accumulated in their home can generally access that amount through a cash-out refinance or home-equity loan and use the money to pay off whatever they need. One point homeowners might not be aware of is that establishing a new mortgage as part of a cash-out refinance could introduce the mortgage insurance requirement. Mortgage insurance protects the lender in the event that the borrower defaults on the mortgage, and the landlord may be required to pay under certain circumstances.
For example, homeowners who have less than 20 percent share capital are generally required to pay mortgage insurance to the lender until they reach that level of capital, at which point they can cancel the mortgage insurance. In addition, mortgage insurance is required for certain types of government-guaranteed loans, such as FHA or USDA loans. A home equity loan avoids the need to worry about mortgage insurance because it's separate from the home's main mortgage. Cashout refinancing and home equity loans are two of the most popular tools available to do so.
Here's what you need to know about each of them to decide which option is best for your situation. Cash refinancing and home equity loans allow you to access your home's equity with a single lump sum payment. In both cases, there are no restrictions on how to use the money. Many people use cash refinances and home equity loans to pay for home renovations or repairs.
Because mortgage loans tend to have lower interest rates than other financial products, some homeowners consider cash-out refinancing to be a good way to consolidate other debts. The biggest benefit of a cash-out refinance is that you don't have any additional payments. It also tends to have a lower interest rate than a home equity loan would have. It's the cheapest way to borrow against your home equity, says Melissa Cohn, regional vice president of William Raveis Mortgage.
A home equity loan is a type of second mortgage. Unlike cash-out refinancing, it doesn't replace your current home loan. Instead, it's a loan in addition to your original mortgage, which means you'll have two monthly payments. Home equity loans generally come with fixed interest rates and terms of between five and 30 years.
These loans also come with closing costs, although they are usually lower than what you will see in a cash-out refinance. Some lenders even cover them completely. In most cases, home equity loans allow you to access up to 80% of the value of your home on both your home equity loan and your mortgage. Some lenders may have limits of up to 90% for certain borrowers.
The main drawback of a home equity loan is that it comes with a second monthly payment. Rates may also be higher, and your interest costs may not be tax-deductible. With home equity mortgages, you can only deduct interest if you use the funds to buy, build, or substantially improve your home. And even then, you would have to itemize your returns to take this deduction.
On the bright side, home-equity loans allow you to maintain the terms of your original mortgage, which could be good if you're far along in your repayment schedule, when a majority of your payments go to your principal balance rather than interest. It's also smart if interest rates on traditional mortgages are rising and you don't want to lose the low rate you already have. To get your home equity loan, you must file an application with your chosen lender, submit documentation, and have your home evaluated. Once you pay your closing costs and sign the documentation, you will receive your lump sum payment a few days later.
Then, you would start making monthly payments for your home equity loan starting the following month. Both home-equity loans and cash-out refinancing can help you convert principal into cash. But the best option depends on your single budget, the terms of your original mortgage, and your long-term plans as a homeowner. Either way, home equity loans and cash-out refinances will likely save you money compared to other financial products you're considering.
Both home-equity loans and cash refinances are types of secured debt with an average interest rate, usually lower than what you'll find with other types of unsecured debt, such as a credit card or personal loans, Straub says. Home equity loans and lines generally come with higher interest rates than cash refinances. They also tend to have much lower closing costs. So, if a new mortgage rate is similar to your current rate and you don't want to borrow a lot of extra money, a home equity loan is probably your best option.
The net worth you have accumulated in your home over the years, whether through principal payment or price appreciation, remains yours even if you refinance the home. In principle, a cash-out refinance gives you the quickest access to the money you've already invested in your property. However, lenders generally don't allow you to borrow all of your capital, and there are different requirements for cash out refinances and HELOCs. A cash-out refinance replaces your current mortgage with a new mortgage loan that has a larger loan amount, allowing you to pocket the cash difference.
Cash refinancing and home equity loans can benefit homeowners who want to convert the accumulated value of their homes into cash. This is because a refinance is considered a first loan, which means that the proceeds from the sale or foreclosure of the home will go towards paying off that loan before the second mortgage or home equity loan is canceled. A lender will determine how much cash you can receive with a cash out refinance, based on the bank's standards, the loan-to-value ratio of your property, and your credit profile. This simplifies things and can release a large amount of cash very quickly, cash that can even help improve the value of your property.
With this type of refinancing, you are applying for a second mortgage in addition to the original one, which means that you now have two liens on your property, which translates into having two separate creditors, each with a potential claim on your home. The decision between cash-out refinancing and a home equity loan may depend on the amount of capital you have accumulated in your home, your creditworthiness, and current lender offerings. You may be able to do a cash-out refinance if you have had your mortgage loan long enough to have accumulated capital. If you don't plan to stay at home for an extended period of time, refinancing may not be the best option; a home equity loan might be a better option because closing costs are lower than with a refinance.
A cashless refinance is the process of refinancing your home for an amount less than or equal to what you owe on your mortgage, plus the closing costs of the new mortgage. Most banks don't allow you to withdraw more than 70% of the current market value of housing, and refinancing costs can be significant. However, if you can't wait, you may be approved for refinancing or a home equity loan, even if you don't have great credit. If you need cash and you have a significant amount of home equity built up, you may want to consider a cash out refinance or a home equity loan.