Home Equity Loan vs. Cash-Out Refinance

Originally published January 18, 2021. This archived article may refer to rules, amounts, or deadlines that have changed. Confirm guidance for your filing year before acting.

Home Equity in a Nutshell

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 any and 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 be under 90 percent. When you add a second mortgage to your home, your original mortgage remains unchanged, but you will have two mortgage payments. ‍

Introducing the Cash-Out Refinance Loan Option

The cash-out refinance loan is a loan that refinances your first mortgage into a larger mortgage, and allows you to take the difference in cash. Assuming you have an adequate amount of equity in your home, a cash-out refinance loan enables 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 amount you want to borrow.
4. Receive the borrowed funds in a lump sum.

  When you elect to use a cash-out refinance loan to tap 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 refinance loans 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 your loan. Consult your tax advisor for more information. ‍

How a Cash-Out Refinance Loan is Different from 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 loan converts one mortgage into a separate larger one. Every other home equity loan option creates 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 since you are changing your loan. Discover Home Loans offers both home equity loan and cash-out refinance options. With Discover, there are no origination fees, application fees, or cash due at closing.

Related service: Mac Neal LLC offers individual tax preparation. Book a call to talk through your situation.