You're ready to cash in on your home's equity, and you're faced with the dilemma of choosing between a home equity loan vs. refinance. How do you know which is best for you? Luckily, you've got us! Today, we're breaking down the differences between a home equity loan vs. a refinance to make your decision a walk in the park.
What Is Home Equity?
Home equity is the difference between what your home could sell versus what you owe on the mortgage. In other words, your home equity is the portion of your property that you actually own. Generally, home equity increases over time as the homeowner pays down the mortgage's balance, as the property value increases, or both. Paying your home down quickly or refinancing to a better rate can increase the rate at which you build home equity.
Home Equity Loan vs. Refinance: What's The Difference?
There are a lot of good reasons why homeowners look to home equity loans and refinancing as a way to put cash in their hands. After all, college tuition, the crack in your foundation or that newly listed investment property aren't going to pay for themselves! While both home equity loan vs. refinance options allow you to turn equity into cash, they are done in two very different ways.
Home Equity Loan
Commonly referred to as a "second mortgage," a home equity loan is an additional loan that allows you to borrow up to 85 percent of your home's equity. Home equity loan approval amounts are dependent upon your income, credit history and the home's market value.
Since home equity loans are "second loans," they are seen as more of a risk and often come with higher interest rates. For instance, the average home equity loan interest rate so far in 2020 is 5.82 percent, much higher than current refinance rates.
Once you decide to take your home's equity out as cash, your home then becomes collateral. This means that if you're unable to pay the loan back, you may be forced to sell your home to satisfy the debts owed. Home equity loans also come with closing costs and fees, ranging from two to five percent of the equity loan amount.
A home refinance is a much different ballgame. Rather than having an additional loan to pay (at higher interest rates) every month, you'll get an entirely new home mortgage loan at current refinance rates. Chances are, current rates are lower than your original mortgage rate, which means more equity in your home and more cash in your pocket.
A cash-out refinance, for example, allows you to refinance your current home mortgage loan to a lower interest rate, term (or both) while putting a cash reserve in your hand for those to-do list (or bucket list) items you've been itching to get done, without using your home as collateral. Like home equity loans, cash-out refinancing allows the borrower to take up to 80-85 percent of their home's value in cash (100 percent cash out for VA loans) and come with closing costs, which vary from lender to lender.
Home Equity Loan vs. Refinance: What's Right For Me?
So, home equity loan vs. refinance, which is right for you? At the end of the day, you'll have cash in your pocket, but with two different means of obtaining it. Are you comfortable with a second mortgage at higher interest rates and your home being held as collateral or a new low-interest rate on a more efficient first mortgage?
Whichever way you choose to cash out your home's equity, be sure to compare your current or prospective mortgage company with other lenders to ensure you're getting the best rates on the market. For instance, you may want to compare mortgage rates of traditional lenders to those of online mortgage lenders. To get an estimate of exactly how much influence the interest rate has on your mortgage, we recommend inputting your figures into a mortgage calculator with taxes and comparing them to current refinance rates.