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Understanding Cash-Out Refinance and Home Equity Loans
What Is a Cash-Out Refinance?
A cash-out refinance is a mortgage loan that allows you to replace your current mortgage with a new, larger one and receive the difference in cash. Ideally, your new mortgage has a lower interest rate and monthly payments. You could opt for a shorter term to pay off your home sooner, or a longer one to lower your payments (although you’ll generally pay more interest over time).
The process of applying for a cash-out refinance is similar to when you initially took out your current mortgage. Your lender will consider your creditworthiness, debt-to-income ratio (DTI), equity, employment, and other factors to determine if you qualify for a cash-out refinance. You’ll repay the amount you borrow with a fixed or variable interest rate over a 15- or 30-year term.
Generally, lenders allow you to borrow up to 80% of your home’s value in a cash-out refinance. For example, if your home is appraised at $400,000, 80% comes to $320,000. If your current mortgage balance is $260,000, you may be able to get a cash-out refi for $320,000 and receive the $60,000 difference in cash.
What Is a Home Equity Loan?
Unlike a cash-out refinance, a home equity loan doesn’t replace your current mortgage. A home equity loan is a second mortgage you’ll repay with another monthly payment.
With a home equity loan, you receive funds as a single lump-sum payment, which you must repay over a fixed term ranging from five to 30 years. These installment loans usually come with fixed interest rates, so your payment will remain the same throughout your term. As with a cash-out refinance, you can use the cash for nearly any purpose.
You may be able to deduct the mortgage interest if you use the funds to buy, build, or substantially improve your home. However, those savings could be offset by closing costs between 2% and 5% of the loan amount, although some lenders don’t charge closing costs.
Home equity loans allow you to borrow up to 80% to 90% of your home’s value based on the combined loan-to-value ratio (CLTV), which takes the balance of your first mortgage and the home equity loan into account.
Cash-Out Refinance vs. Home Equity Loan
Cash-Out Refinance
- Replaces your current mortgage: Yes
- Interest rates: Fixed or variable
- Repayment terms: 15 to 30 years
- Closing costs: Yes
- Tax deductible: If you use the money to improve the home
- Application process: More intensive, includes a closing period
Home Equity Loan
- Replaces your current mortgage: No
- Interest rates: Often fixed
- Repayment terms: Five to 30 years
- Closing costs: Lenders may cover the costs
- Tax deductible: If you use the money to improve the home
- Application process: Less intensive
When to Use a Cash-Out Refinance
Deciding whether to use a cash-out refinance depends on your unique financial situation. This option may make sense in certain scenarios, such as when:
- The interest rate on a refinance loan is lower than your existing mortgage, and you need extra funds.
- You want to accelerate the time to pay off your home with a shorter repayment term.
- You want extra cash at a lower interest rate to cover unexpected medical bills, pay educational expenses, or consolidate high-interest debt.
- You want a tax break on mortgage interest if you plan on using the funds to renovate your home.
When to Use a Home Equity Loan
A home equity loan is a popular option for borrowers looking to access cash at a fixed rate. You might consider utilizing a home equity loan in the following situations:
- When you want extra funds to reach a financial goal but don’t want to refinance your existing mortgage, especially if your current mortgage rate is lower than existing refinance rates.
- When you want to consolidate multiple high-interest debt accounts into a single, lower-interest payment.
- When you’re facing a large unexpected expense or short-term financial need and don’t want to pay the higher closing costs of a refinance loan—some home equity lenders may even waive closing costs.
- When you plan to use the funds to buy, build, or substantially improve your home and wish to deduct the mortgage interest.
Contact O1ne Mortgage for Your Mortgage Needs
At O1ne Mortgage, we are dedicated to helping you find the best mortgage solution for your needs. Whether you’re considering a cash-out refinance or a home equity loan, our team of experts is here to guide you through the process. Call us today at 213-732-3074 to discuss your options and take the next step toward achieving your financial goals.
