Cash-out refinancing versus home equity loans
What is cash-out mortgage refinancing?
Cash-out refinancing involves refinancing your mortgage for more than you currently owe and pocketing the difference. If you have been paying down your mortgage for some time, then the principal is likely to be substantially lower than what it was when you first took out your mortgage. That build-up of equity will allow you to take out a loan that covers what you currently owe -- and then some.
For example, say you owe $90,000 on a $180,000 house and want $30,000 to add a family room. You could refinance your mortgage for $120,000, and the bank will then hand over a check for the difference of $30,000.
You can take the difference and use it for home renovations, second-property purchases, tuition, debt repayment or anything else that needs a significant amount of cash. What’s more, you may be able to get a more favorable interest rate for your refinanced mortgage.
However, if the interest rate offered for your refinanced mortgage is significantly higher than your current rate, this may not be a sensible choice. A home equity loan or line of credit (HELOC) might be a better option in this instance.
Typically, homeowners are allowed to refinance up to 80 percent of their property’s value. Certain lenders may allow you to borrow more than 80 percent of your home’s value, but you may have to pay private mortgage insurance, or pay a higher interest rate.
Homeowners sometimes confuse these two pools of home-financed cash. Cash-out refinancing and home equity loans are quite different. Cash-out refinancing is a replacement of your first mortgage; HELOCs are separate loans on top of your existing mortgage. In other words, with refinancing you get a new mortgage, not a second loan against the equity in your home.
Refinancing usually makes sense only when there has been a drop in interest rates and you want to lock in a new mortgage at a lower rate for a longer term than your existing mortgage. It can also benefit those who want to refinance their mortgages for a longer term to lower their monthly payments.