Owning a home is an expensive undertaking. But your home can make you money through equity, and it may be time to turn that wealth into cash.
You can lower your interest rate, convert equity to cash, or both through options such as an equity loan or cash refinancing. While both give you the option to redeem the value of your home, each works differently. Here’s the difference between a home equity loan and cash-out refinancing so you know which one is right for you.
What is a home loan?
A equity loan is a lump sum payment, usually with a fixed interest rate, that serves as a second mortgage. Your home serves as collateral to secure the loan based on how much equity you have in your home. The longer you own your home, the more equity you have at your disposal.
Your credit score is less important to lenders as your home is used as collateral, otherwise known as a secured loan. As you continue to pay off your first home loan, you are responsible for the second mortgage, or your home loan. So you have to pay off two mortgages at the same time. Lenders usually pay your closing costs if you take out a second mortgage.
What is cash-out refinancing?
Cash-out refinancing is when you take out a new loan to replace your mortgage and use the equity you’ve built up to “cash in.” Your new loan may have a longer term, a lower interest rate, or both. Since you get a new loan, you can pocket the money you receive from refinancing.
Cash-out refis usually come with fixed interest rates, although some lenders offer adjustable rates. Interest rates are generally lower compared to equity loans. However, with this option you are on the hook for closing costs.
Which one is right for you?
Ask yourself a few questions before deciding which one is best for you.
Can I lower my interest? Lower interest ratescan generally be a good time to refinance your home. But instead of paying two loans at once, avoid a home equity loan and opt for a cash-out refinancing. That way, you’re not paying for a home you bought when rates were higher.
Which one do I qualify for? A home equity loan is a type of second loan, meaning it has the second priority over the first. They are usually more difficult to qualify than cash-out refinancing. A payout is like a brand new loan, which means it has the first priority.
How long does it take to refund? Home equity loans are usually shorter, with maturities of about 15 years. Refinancing terms for payouts usually range from 15 or 30 years, such as a regular mortgage. However, keep in mind that the longer the term, the more interest you will pay over the term of the loan.
What can I expect in interest? Both home equity loans and cash-out refis offer competitive interest rates. But if you shop around and can’t find interest rates lower than what you’re paying now, it might not be worth trying either.
Do I get tax on the proceeds? Unless you’re selling your home, don’t expect to pay capital gains tax from either a home equity loan or cash-out refinancing. In both cases, they are loans, or money that you borrow with the intention of paying back. They are therefore not taxable.
Can I pay two loans? If you can pay off both your first mortgage and your home equity loan, having two payments shouldn’t be a problem. But if you think you would struggle to make payments, a payout refi would work better for you as you get one monthly mortgage payment.
It comes down to
The main difference between a home equity loan and a cash-out refinancing loan is that a cash-out refinancing loan converts one mortgage into a separate larger one. In most cases, the more money you need, the more logical a payout refinance is. Home equity loans create a second mortgage and usually have lower closing costs than a cash-out refinance, but also come with higher interest rates.
Consider talking to a financial advisor about whether it makes sense to convert your home’s equity into cash, and if so, what’s the best way for you to do it. Finding the right financial advisor to suit your needs doesn’t have to be difficult. SmartAsset’s free tool connects you to financial advisors in your area within five minutes. If you are ready to be matched with local advisors who will help you achieve your financial goals, start now.
Before choosing between a home equity loan and a cash-out refi, rethink your current home situation. How much do you have equity in the house?? If you recently bought your home, you may not qualify for either one because you haven’t paid long enough to acquire equity. However, if you’ve owned your home for a few years, you can expect to hold a significant amount of equity and potentially spend money on it.
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