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The Difference Between a Cash-Out Refinance and a Home Equity Loan
If you're looking to tap into your home's equity to make a big purchase or pay off high-interest debt, you may be considering a cash-out refinance or a home equity loan. While both of these options allow you to borrow against your home's value, they work differently and have their own pros and cons. In this article, we'll explore the differences between a cash-out refinance and a home equity loan to help you decide which one is right for you.
What Is a Cash-Out Refinance?
A cash-out refinance is when you replace your existing mortgage with a new one that's larger than your current loan balance. The difference between the two loans is given to you in cash, which you can use for any purpose. For example, if you have a $200,000 mortgage and owe $150,000 on it, you could refinance for $175,000 and receive $25,000 in cash.
The amount you can borrow with a cash-out refinance is limited by the equity you have in your home. To calculate your home equity, subtract your outstanding mortgage balance from the appraised value of your home. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in home equity.
When you do a cash-out refinance, you'll have a new mortgage with a new interest rate and terms. Depending on current market conditions and your creditworthiness, you may be able to get a lower interest rate or better terms than you had with your old mortgage.
What Is a Home Equity Loan?
A home equity loan, also known as a second mortgage, is a loan you take out against the equity in your home. Unlike a cash-out refinance, you don't replace your existing mortgage with a new one. Instead, you have two loans: your original mortgage and a home equity loan.
You can typically borrow up to 80% to 90% of the equity in your home with a home equity loan. For example, if you have $100,000 in home equity, you may be able to borrow $80,000 to $90,000.
Home equity loans have fixed interest rates and terms, which means your monthly payments will stay the same throughout the life of the loan. This can make budgeting easier, as you'll know exactly how much you'll owe each month.
Which Is Better, a Cash-Out Refinance or a Home Equity Loan?
The answer to this question depends on your individual circumstances. Here are some factors to consider:
- Interest rate: If you can get a lower interest rate with a cash-out refinance, it may be a better option. Home equity loans tend to have higher interest rates than first mortgages.
- Loan amount: If you need to borrow a large amount, a cash-out refinance may be your only option. Home equity loans typically have lower borrowing limits than cash-out refinances.
- Repayment timeline: If you want to pay off the loan quickly, a home equity loan may be a better choice. Cash-out refinances usually have longer repayment timelines than home equity loans.
- Tax benefits: In some cases, the interest you pay on a home equity loan may be tax-deductible. This is not the case with a cash-out refinance. Consult with a tax professional to see how this may affect your situation.
Ultimately, the decision between a cash-out refinance and a home equity loan comes down to your goals and financial situation. Consider speaking with a mortgage professional to explore your options and find the best solution for you.