Home Equity Loan or Cash-Out Refinance: Which Is Best?

Both cash-out refinances and home equity loans let you borrow against the equity in your home. Equity is the difference between what your home is worth and what you owe on your mortgage. If your home is worth $350,000 and you owe $200,000 on your mortgage, you have $150,000 in equity.

Lenders will let you borrow a percentage, usually up to 80%, of that equity in the form of a home equity loan or cash-out refinance.

Home equity loans

If you have $150,000 in equity, your lender might approve you for a home equity loan of $120,000. Home equity loans come with terms that range from five to 30 years.

You'd receive the cash from a home equity loan in one payment. You'd repay this loan, in addition to your primary mortgage, in regular monthly payments with interest. In other words, with a home equity loan, you'll make two mortgage payments each month.

You can use the money from a home equity loan however you'd like — for such things as home repairs or renovations, paying off credit card debt or paying a child's college tuition. Or you could use the money to pay for improvements that boost the value of your home. If you choose the latter option, you can write off the loan's interest on your taxes. (You don't get this tax break if you use your home equity dollars in any other way.)

Cash-out refinances

With a cash-out refinance, you swap your current mortgage for a new one, refinancing for more than what you owe on your current mortgage. You take the difference between the old loan and the new one as a cash payment that you can spend however you'd like. A cash-out refinance leaves you with one new loan, so still only one payment each month.

Say you owe $200,000 on your mortgage. You might refinance for a new loan of $280,000. You'd receive the extra $80,000 as a single payment. However, you would have a higher mortgage balance, paying off $280,000 instead of $200,000. As with a home equity loan, if you spend the money on home renovations, you can write off the interest on your taxes.

Which option is better?

There is no clear answer as to whether a cash-out refinance or home equity loan is a better option. They each come with their own pluses and minuses.

With a home equity loan, you have to keep track of two monthly mortgage payments. These loans also come with slightly higher interest rates than cash-out refinances. A home equity loan, then, might be more expensive over time.

A cash-out refinance leaves you with just one mortgage payment and usually comes with a lower interest rate. Cash-out refinances also tend to come with higher closing costs than home equity loans — usually 2% to 6% of the total new loan amount. This means that to save money over a home equity loan, you'll often have to stay in your home longer. But if you do plan to stay in your home for a while, a cash-out refinance, even with these higher closing costs, generally is less expensive than a home equity loan.

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