Home Equity Loan vs Cash Out Refinancing - whats better?

Cash Out Refinance vs Home Equity Loan 

When it comes to getting cash to fund a major project or expense, many people look at using their home as colateral on a loan, or using the accumulated equity they have in their home as a way of securing cash.  There are a number of ways to go about this, but two of the most common, and popular are Cash Out Refinancing, and a Home Equity loan.  Both options have significant advantages and disadvantages depending on your situation, and while on the surface they may look similar, in practice, they are quite different.

 
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Refinancing with Cash Out

One of the most popular forms of equity release, especially at the moment is cash out refinancing.  When you refinance with cash out, what you are essentially doing is taking out a new mortgage loan that is larger than your current one, and using it to pay off the old mortgage you have.  Because the new mortgage is bigger than the old one though there will be a suplus left over, and this is given to you in cash, to use as you wish.  

Advantages of Cash Out Refinance
This method of equity release can have a number of advantages over an Equity loan:
  • You can refinance your whole mortgage loan down to a lower interest rate than you currently have, if lower ratesare available.
  • You can shorten or lengthen the term of your loan and therefore adjust the repayment amounts to better suit your current needs.  You can also change to a fixed rate mortgage or Adjustable rate.
  • Because you still only have a single mortgage (Home Equity Loans are generally a second mortgage) the interest rates are generally significantly lower than an Equity Loan.
  • If your credit has improved, you may be able to get a lower interest rate, or remove any PMI (Private Mortgage Insurance) that may have been required by your lender when you first took out your mortgage.
Disadvantages of Cash Out Refinancing
There are also some down sides to a cash out refinance which should be considered:

  • There may be early repayment fees, or "Points" payable when you refinance your mortgage.  If you only recently took out your mortgage these can be very high.
  • You cannot pay off the "cashed out" part of the mortgage more quickly - it forms part of the overall loan which is all paid off over the same period of time.
The key thing to remember with a Cash out refinance is that it affects your whole mortgage, where as a Home Equity Loan is a completely separate loan.  This gives you the opportunity to "reset" your loan and set it up in a way that better suits your current needs, but there are also costs involved. 

Home Equity Loans

Unlike a cash out refinance, a Home Equity Loan does not replace your current mortgage, rather it is a separate loan that exists alongside your normal mortgage loan.  A Home Equity Loan is generally a second mortgage, and is used when your property has risen in value, or you have paid off a lot of the mortgage through your normal repayments.  Like cash out refinancing, a Home Equity Loan has its own advantages and disadvantages:

Advantages of Home Equity Loans
  • No refinancing costs or Points.  This is a new loan that doesn't replace the existing mortgage.
  • Can be repaid more quickly than your regular mortgage - most Equity Loans are paid off over 10 years.
  • The Home Equity Loan can be taken out with a different lender to your main mortgage.
  • Paying the loan off over a shorter time minimises interest costs.
Equity Loans provide flexibility by allowing you to borrow from a different lender and arrange repayments to suit.  Depending on your other financial commitments, you can elect to pay your Home Equity Loan off very quickly if you wish, and therefore dramatically cut down the interest you'll accumulate.

Disadvantages of Equity Loans
There are also some negatives to the Home Equity Loan that you may want to consider:
  • Interest rates are higher than standard mortgage loans.
  • Lenders may offer to let you borrow a little less than if you refinanced with cash out.
Leners offering equity loans often work on a fixed maximum LTV ratio, and this can affect how much you can borrow in total.  As home equity loans are generally second mortgages and thefore less ecure in the lenders eyes, they maximum LTV ratio they will accept may be less than if you were to utilise cash out refinancing.  For more information of how much you can borrow with an equity loan and how this amount is calculated, check out our article on the subject here.

Which is the Better Option?

As ypu can see, both choices have their benefits.  In general, if you have only recently taken out your mortgage, or you are already on a good interest rate and don't want to change it, then a Home Equity Loan is probably your best bet.  Alternatively, if you are considering refinancing anyway, in order to take advantage of lower interest rates, or changing the term or structure of your home loan, then a cash out refinance may suit you better.  As with most situations involving mortgages and finance, there isn't a universal "right" answer, and your decision needs to be based on which option will work best for your personal circumstances.