The core difference between a home equity loan and a cash-out refinance lies in their relationship to your primary mortgage and their position in your home's lien structure. A cash-out refinance replaces your existing mortgage entirely and is considered a first loan, while a home equity loan is a separate, additional loan that acts as a second mortgage on your property.
Understanding Home Equity Loans
A Home Equity Loan (HEL) allows you to borrow a lump sum against the equity you've built in your home. It functions as a separate loan from your existing mortgage.
- Key Characteristics:
- Second Mortgage: As stated in the reference, a home equity loan is a second loan and is considered a second mortgage. This means your original mortgage remains in place, and you'll have two separate monthly payments: one for your primary mortgage and one for your home equity loan.
- Fixed Interest Rates: HELs typically come with fixed interest rates, providing predictable monthly payments over the loan term.
- Lump Sum Payout: You receive the entire loan amount upfront, which can be useful for specific, large expenses.
- No Impact on First Mortgage: Your original mortgage terms (rate, payment schedule) remain unchanged.
Understanding Cash-Out Refinance
A Cash-Out Refinance is a type of mortgage refinance where you replace your current mortgage with a new, larger mortgage. The difference between the new loan amount and your existing mortgage balance is given to you in cash.
- Key Characteristics:
- First Loan: The reference highlights that cash-out refinances are first loans. This means they pay off your existing mortgage and replace it with a new one. You only have one mortgage payment after a cash-out refinance.
- New Mortgage, New Terms: You get a brand-new mortgage with potentially different interest rates, loan terms, and payment schedules.
- Better Interest Rates: As per the reference, cash-out refinances often have better interest rates compared to home equity loans because they are the primary lien on your property, making them less risky for lenders.
- Consolidation: It allows you to consolidate your home loan into a single payment.
Key Differences at a Glance
The table below summarizes the primary distinctions between a home equity loan and a cash-out refinance:
Feature | Home Equity Loan (HEL) | Cash-Out Refinance |
---|---|---|
Loan Type | Second mortgage (separate loan) | New primary mortgage (replaces old one) |
Lien Position | Second lien / Second loan | First lien / First loan |
Existing Mortgage | Remains in place | Paid off and replaced |
Number of Payments | Two (original mortgage + HEL) | One (new, larger mortgage) |
Interest Rates | Generally higher | Generally lower (as per reference) |
Closing Costs | Typically lower than refinance | Generally higher (similar to a new mortgage) |
Loan Amount | Based on equity, usually capped lower than refinance | Based on equity, often allows access to more equity |
Practical Considerations and When to Choose Which
Understanding when to choose a home equity loan versus a cash-out refinance often depends on your financial goals, current mortgage rate, and tolerance for closing costs.
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Choose a Home Equity Loan if:
- You have a low interest rate on your existing mortgage that you don't want to lose. An HEL allows you to tap equity without touching your first mortgage.
- You need a lump sum for a specific project (e.g., home renovation, debt consolidation, educational expenses).
- You want to avoid the higher closing costs associated with a full mortgage refinance.
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Choose a Cash-Out Refinance if:
- Your current mortgage interest rate is high and you want to reduce it while also accessing cash.
- You want to simplify your finances by having only one mortgage payment.
- You need a larger amount of cash than what might be available through a second mortgage, or you want to access a higher percentage of your home's equity at potentially better rates.
- You plan to stay in your home long enough for the savings from a lower interest rate to offset the closing costs.
Both options allow you to convert your home equity into usable funds, but they do so through fundamentally different structures, impacting your interest rates, monthly payments, and the status of your existing mortgage.