Mortgage Refinance or Home Equity Loan: Which is Better for Me?
One of the biggest advantages to owning your home is the ability to tap into the equity you build, or the amount of your house that you’ve paid off. When you need to access that equity as cash, though, you’re faced with a couple of options. Cash-out refinances and home equity loans are two of the most popular methods for using your home’s equity. Which is the better option for you? Looking at the similarities and differences between a refinance and a home equity can help you answer that.
What are Cash-Out Refinances and Home Equity Loans?
A cash-out refinance allows you to refinance your mortgage at an amount that is more than the amount you owe, as long as the value is high enough. After you close on the new mortgage, you pocket the extra cash. A home equity loan, on the other hand, is similar to a personal loan except that it is secured by your home. The amount you can borrow is determined in part by how much equity you’ve built up.
Everything you need to know about refinancing your mortgage.
Three ways Mortgage Refinancing and Home Equity Loans are similar
Before we dig into how refinances and home equity loans differ, let’s take a look at how they’re alike. Their similarities center around:
How you receive the funds
The interest rate for both a mortgage refinance and a home equity loan will likely be fixed. The advantage with this, of course, is that your monthly payment stays the same and budgeting is easier to manage. With a fixed rate, you don’t have to worry about your payment rising.
While interest rates on home equity loans are typically fixed, rates on home equity lines of credit are often variable. Check out this article
for more differences between home equity loans and home equity lines of credit.
For both a refinance and home equity loan, you’re going to need equity in your home. In the simplest terms possible, equity is the amount of home you actually own. To estimate your equity, subtract how much of your mortgage you owe from the current value of your home.
It’s important to keep in mind that other factors impact your equity, like what the current value is of your home. Estimate your home’s current value here.
You get a lump sum
With both a cash-out refi and a home equity loan, you’ll receive your funds as a lump sum. When you refinance your mortgage, the amount you’re approved for pays off your current mortgage. You can, however, opt for a cash-out refinance, in which case your new mortgage is higher than what you owed on your first mortgage and you pocket the difference. Either way, the funds from the refinance are disbursed as a single sum.
When you close on a home equity loan, you’ll receive the amount you’re approved for as a lump sum. You can use the funds however you wish; if you don’t plan on using them right away, it’s smart to put them into a special savings account to avoid using the money for anything other than its intended purpose.
► Pro Tip: Keep in mind that throughout this article we are specifically talking about refinancing versus home equity loans. A home equity line of credit is an entirely different product. Check out our article for an overview of home equity loans and HELOCs.
So which is better for you: Refinancing or a Home Equity Loan?
So now you know how mortgage refinancing and home equity loans are the same, but it’s understanding how they’re different that will help you figure out which is better for you. The three biggest differentiators are:
Number of liens
While refinances and home equity loans both offer fixed interest rates, you may find that one carries a lower rate than the other. Typically, a cash-out refinance will have a lower interest rate because it is a first lien, meaning that in the event of a bankruptcy or foreclosure it will be paid first. A home equity, on the other hand, is a second lien and will be in second position, behind your mortgage. This means the interest rate on a home equity may be slightly higher.
A lien is a kind of security a lender has to guarantee payment. The security can be a car or truck for auto loans or a house for mortgages and home equities. The person or business who benefits from the lien – for example the bank who holds your mortgage – is known as the lienholder.
Check with the financial institution that holds your mortgage. You’ll want to find out what their rates look like, and then shop around to see what other lenders are offering.
One of the biggest differentiators between refinancing and home equity loans are the costs associated with both. For either product, you’ll likely have to pay for an appraisal so that the lender knows exactly how much your property is worth. They then use this information to determine how much they can lend to you. The difference in how much you’ll be paying out of pocket really hits home when it comes to closing costs. Remember when you closed on your home? You had to pay a pretty hefty sum at closing. This amount includes appraisal, title fees, attorney fees, and escrow amounts. You’ll have to pay similar closing costs if you refinance a mortgage. Why? Because when you refinance, you’re essentially paying off your mortgage and starting a new mortgage, including all the associated costs. So why would someone even think about a refinance? Most commonly, refinancing helps those who locked into a higher rate when they purchased their home save money by securing a lower rate, even when the closing costs are added in.
Many financial institutions, including MHV, will pay the closing costs on a home equity loan on your behalf and refund your appraisal fee at closing. This can potentially mean huge savings for you. There are typically some stipulations, such as keeping your loan open for a certain number of years. If you need to finance a relatively small amount of money, it may not be worth paying the closing costs on a mortgage refinance, making a home equity loan a better option.
Number of liens
At this point, you may be thinking that the benefits of a home equity loan far outweigh those of a refinance. Here’s where the tables turn.
When you apply for and close on a home equity loan, you are opening a second lien on your home. In other words, both your mortgage and your home equity are secured by your home as collateral. It also means an additional debt on your credit report.
A mortgage refinance on the other hand replaces your original mortgage, meaning there is no second lien or additional debt. Because you’re replacing one loan with another, there is no lien in the second position.
There is nothing inherently wrong with having a second lien; it is purely a matter of personal preference and your financial situation. It is an important factor to weigh, though, when deciding whether refinancing your mortgage or opening a home equity loan is a better fit for you.
Making Your Decision
When it’s time to decide which is the right choice for you, look at the similarities and differences between refinancing your mortgage and applying for a home equity loan. Keep in mind, too, the difference in terms between mortgages and home equity loans. Home equity loans will have a shorter term. This means your monthly payment may be higher than a mortgage refinance but you’ll have the loan paid off quicker. Talk to your financial institution and, if you have one, your financial advisor. Weigh everything you learn with your personal needs and preferences.
Mortgage Refinance vs. Home Equity Loan: A Quick Reference