Cash-Out Refinance vs. Home Equity

Do you want to access some of the value that has accumulated in your home? You have two options: a cash-out refinance or a home equity loan. These loans have some things in common, but they are not the same.

If you already have a mortgage, taking out a home equity loan means another monthly payment. On the other hand, a cash-out refinance will supplant your current mortgage with a new one with a new interest rate, higher loan amount, term, and monthly payment.

Before deciding for one loan or another to access your equity, it is wise to understand all aspects of cash-out refinance and home equity loans. Which is best for you depends on many factors that we will explore in detail below.

Why Get a Cash-Out Refinance or Home Equity Loan?

Many say that purchasing a home is like having a forced savings account. When you make your monthly mortgage payment and the property appreciates, you build your equity in the house.

But you cannot easily access that equity any time you like. You have to sell the home. Another option is to borrow some of the equity while you are still in the home. A cash-out refinance and home equity loan allow you to do that.

Naturally, you will need to have some equity in your property to get one of these loans. If you bought your home recently, you might not have a lot of value accrued yet.

After you have owned your house for at least five years and made payments on time, you may have enough equity to pull out, according to Johnna Camarillo, assistant VP at Navy Federal Credit Union.

Borrowers typically use cash out to improve the home, pay off debt, or make college tuition payments.

How To Figure Out How Much Equity You Have

First, find out what the value of your home is. Next, find out how much you owe on your home loan. If the difference between the numbers is a positive one, you have that much equity in the property. But if you owe more than what the home is worth, you cannot get a cash-out refinance or home equity loan at this time.

Keep in mind that you generally need to have at least 10% to 20% equity in the home before you can pull out cash, according to Bankrate.com.

How Are The Loans The Same?

A cash-out refinance and a home equity loan usually has fixed interest rates, but you can get an adjustable-rate with a cash-out refinance.

You usually need a loan-to-value ratio (LTV) of 90% or less to qualify for either loan.

Both loans usually give you a lump sum of cash at closing.

How Are The Loans Different?

Interest rates are lower for cash-out refis than home equity loans. This is because if there is a foreclosure, the lienholder on the first mortgage gets paid first. Home equity loans are, therefore, considered a higher risk for the lender.

Lenders may pay all or most of your closing costs on home equity loans, but not on cash-out refinances.

A mortgage-refinance is one large loan, while a home equity loan is a second mortgage.

Common Questions About Cash-Out Refis vs. Home Equity Loans

Which loan is easier to get?

The borrower usually can qualify easier for cash-out refinance. It is a replacement for your first mortgage. Your lender likes that because they are in ‘first position’ if there is a foreclosure.

Home equity loans are second mortgages and are considered a riskier bet for the lender.

How much money can I borrow?

It depends, as with most things. The amount you can borrow depends on the equity you have in the property, credit score, and debt-to-income ratio. Also, some states, such as Texas, limit the equity you can take out. A home equity loan cannot exceed 80% of the fair market value of the property in The Lone Star State.

When do I have to pay the money back?

A cash-out refinance usually can go 15 to 30 years. Home equity loans usually have a 10 or 15-year term.

Experts recommend to get the shortest term you can, but still have a mortgage payment that will not break you. Depending on the cash you borrow, the payment difference between a 10 and 15-year home equity loan may only be $50 or $75 per month. But the interest you will pay over that additional five years is thousands of dollars.

Am I going to get taxed?

You will not be taxed on the equity you pull out of a cash-out refinance or home equity loan because it is borrowed money that must be paid back.

However,  the mortgage interest deduction is another question. For home equity loans set up in 2018 or later, “the proceeds need to be used to buy, build, or substantially improve the taxpayer’s home that secures the loan,” according to the IRS.

For a cash-out refi, it is the same as all first mortgages. As of 2018, the mortgage interest deduction is limited to loans of $750,000 or less, or $375,000 for a married taxpayer who files a separate tax return.

Final Thoughts on Cash-Out Refinance vs. Home Equity

Which home loan you take out depends on your individual circumstances. Generally, if you have an interest rate that is lower than the current market, it may make sense to keep your first mortgage in place and get a home equity loan.

If your first mortgage rate is .5% or higher than current rates, you may consider doing a cash-out refinance.

The best bet is to chat with your mortgage loan officer or broker who can advise you on the best mortgage product to fit your individual needs.

References

Author: Bryan Dornan

Bryan Dornan is a financial journalist and currently serves as Chief Editor of Cash Out Refi Tips.com. Bryan has worked in the mortgage industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.

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