When you’re looking to tap into your home’s equity, two major options come to mind: a home equity loan and a cash-out refinance. Both allow you to access the value built up in your property, but they differ not only in structure and interest rates. They also vary significantly in terms of cost.
To make the best financial decision, it’s essential to break down and compare the expenses involved in a home equity loan vs cash-out refinance.
Let’s do that without further ado.
Origination and Closing Costs
Cash-out refinances typically come with higher upfront costs because they require you to go through a full mortgage refinance process. This includes lender fees, home appraisal, title search, recording fees, and other closing costs, which are generally between 2% and 5% of the new loan amount. Since you’re replacing your existing mortgage, these costs are unavoidable.
In contrast, home equity loans often have much lower upfront fees. Some lenders even offer no-closing-cost home equity loans, though this may result in a slightly higher interest rate. Because it functions as a second loan rather than replacing your first mortgage, a home equity loan involves a simpler application process and fewer administrative fees. This is the basic difference between a home equity loan vs cash-out refinance.
Interest Rates
Interest rates can make a big difference in the long-term cost of borrowing. Home equity loans usually have fixed interest rates, which means your monthly payments remain consistent throughout the loan term. However, these rates are typically higher than those offered for primary mortgages because home equity loans are considered second-lien loans (i.e., riskier for lenders).
Cash-out refinances, on the other hand, often offer lower interest rates because they’re primary mortgage loans. If current mortgage rates are lower than what you’re currently paying, a cash-out refinance could save you money over time. The comprehensive guide on AmeriSave about this difference can be a good starter if you want to explore more.
Loan Terms and Repayment Period
Another cost-related consideration is the repayment period. Home equity loans often come with shorter loan terms. This is typically 5, 10, or 15 years. While this means you’ll pay less interest over the life of the loan, your monthly payments may be higher than with a refinance.
Cash-out refinances usually follow standard mortgage terms of 15 or 30 years, which can lower your monthly payments. However, spreading the repayment over a longer term increases the total interest paid, even if the rate is lower. So, while it might be easier on your monthly budget, it could cost more in the long run.
Which Option is More Cost-Effective?
The better option between a home equity loan and a cash-out refinance depends on your specific financial goals:
- If you need a small amount of cash and want to avoid high upfront fees, a home equity loan may be more affordable.
- If you’re looking for a large sum and your current mortgage rate is high, a cash-out refinance could be a smarter move, especially if market rates are now lower.
Ultimately, comparing the total cost of borrowing, including interest paid over time and all associated fees, is key. Use loan calculators or speak with a mortgage advisor to simulate different scenarios and determine the most cost-effective option for your situation.
