Cash out refinance vs Home equity loan

Are you thinking about refinancing your home? Or maybe you’re considering taking out a loan so that you can pay off debt or renovate your home. A cash out refinance can give you an opportunity to do both with a single loan, but a home equity loan might be a better option if you’re happy with your current mortgage.  Both options can be a good decision for current homeowners, but there are some details you will want to consider before deciding which one works best for you.

What is a home equity loan?

Home equity loans best suit borrowers who have a substantial amount of equity available to them. You can determine the total amount of equity in your home by subtracting all debts secured by your house from the current fair market value of your home. The amount left over is the total equity, or value of ownership, of your house.

Usually, the amount you can borrow is determined by your credit and combined loan-to-value (CLTV) ratio. Your CLTV is your desired home equity loan amount plus your existing mortgage balance, divided by your home’s value.

Your CLTV must typically remain under 90 percent. When you add a second mortgage to your home, your original mortgage remains unchanged, but you will have two mortgage payments.

What is a Cash-Out Refinance?

A cash out refinance is a loan that refinances your first mortgage into a larger mortgage which allows you to tap into your equity and take the difference in cash.

Assuming you have an adequate amount of equity in your home, a cash out refinance makes it possible for you to:

1. Pay off your existing mortgage.
2. Negotiate a new term, rate, and repayment schedule for your consolidated loan amount.
3. Obtain a new mortgage in the amount of your existing mortgage, plus the additional amount you want to borrow.
4. Receive the additional amount in a lump sum.

When you elect to use a cash out refinance loan and access your home equity, you enter into a whole new loan agreement. This means the terms, rate, and repayment plan for your new mortgage will be different.

Generally, cash out refinances offer up to 30 years for repayment, and you can choose between a fixed or adjustable interest rate. You may even be able to take advantage of potential tax savings depending upon how you are using the “cash out” portion of your loan (e.g. home improvement). Consult a tax advisor for information about your eligibility for this deduction.

Difference between a cash out refinance and a home equity loan

The primary difference between a cash out refinance loan and other home equity loan options is that a cash out refinance converts one mortgage into a separate larger one. Other home equity loan product options typically create a second mortgage on your home.

With a traditional home equity loan, you take on a second mortgage at a fixed rate with up to 30 years for repayment. One thing to consider is the fees associated with each loan. Cash out refinancing may have fees and closing costs because you are changing your loan.