Did you know that there are two ways to get much-needed cash by using the equity you've built up in your home? Both a cash-out refinance and a home equity loan can help you reach a financial goal, whether that's helping to consolidate debt, making home improvements, or paying for a major life expense.

So, how are these two options different? Which one is right for you? Here, we'll break down the differences between these two cash solutions so that you can make an informed decision as to which most closely aligns with your needs and situation.

Cash-Out Refinance

At its core, a cash-out refinance is a new mortgage agreement for a loan that is more than what you owe on your home. Why more? Because you're tapping into the equity you've built over the years. You'll get an immediate sum of money at closing, and you can use that money for any number of things.  Popular uses for a cash-out refi include:

  • Home improvements
  • Purchasing a second property
  • Paying off credit cards
  • Sudden unexpected expenses

At closing, your new loan is first used to pay off your old mortgage, as well as any fees and closing costs that are associated with your cash-out refi. You receive the sum of money that is left after those costs have been deducted.

Note: In most cases, you cannot get a cash-out refi for the entire value of your home.

Financial institutions typically require that you leave a portion of your equity in the home. How much equity depends on the type of cash-out refinance you're securing. For instance:

  • Most conventional cash-out refis require that you leave 20% equity
  • FHA loans typically require 15%

As there are exceptions to nearly every rule, a VA cash-out refinance does allow a homeowner to get a loan for 100% of the value of their house. Of course, not everyone qualifies for this type of cash-out refinance, as it's intended to benefit U.S. military personnel and their families.

Home Equity Loan

A home equity loan is a second loan. It does not replace the mortgage you currently have, so nothing on your original contract would change.

Instead, you'd have an entirely separate agreement, one that allows you to borrow against the equity you've built. Because it is a separate agreement, home equity loans tend to have higher interest rates than a first mortgage.

Borrower tip: Many confuse home equity loans with a home equity line of credit (HELOC). These are two different ways to use the equity you've built up, so make sure you're inquiring about the right kind of loan.

How does a home equity loan work? Once it closes, you'll get a lump sum of cash, which you'll need to make payments on. Lenders do have limits as to the amount of money you can borrow. There are some situations in which you may be able to borrow 100% of your equity, but that's rare.

Comparing the Two

Similarities

These two types of cash solutions share many similarities. Both a cash-out refinance and home equity loan borrows against the equity in your home, and in most cases, you can't take 100% equity from your home.

Both offer immediate cash upon closing, which is a big perk for borrowers.  Additionally, there are many ways you can choose to spend the money you receive.

As you are using your home as collateral, these two cash solutions typically offer more competitive rates than other types of loans do, making them great options for those with unexpected expenses.

Differences

There are some very important differences to note between these two options. The first, and arguably the most important, is that cash-out refinances tend to have better interest rates than home equity loans.

Why? Because a cash-out refinance is a "first loan," and a home equity loan is a second one. That means that should you, the borrower, find yourself in a bankruptcy situation, first loans will be paid before any others. This guarantee gives the lender more peace of mind and makes them more willing to offer competitive interest rates.

Another key difference that is important for borrowers to understand is that a cash-out refinance pays off your original mortgage contract and replaces it with a new one.

A home equity loan is a completely separate, new loan, which means you're adding another payment to your monthly expenses.

Which is Right for You?

On average, a cash-out refinance offers more perks and rates for a borrower than a home equity loan. If the value of your home has risen since you purchased it, or if you've built up quite a bit of equity over the years, a cash-out refi may make the most sense from a financial standpoint.

Tip: Keep a close eye on your equity! If you drop below a certain percentage, that may trigger the need for private mortgage insurance.

If you need money during times when refinance rates are high, it may make sense to explore a home equity loan. That being said, it's important to crunch the numbers to understand your bottom line. The last thing you need is to take on payments that will financially strain you in the long run.

A lot of the decision comes down to interest rates. The good news for borrowers is that interest rates for cash-out refinances are at historic lows! Connect with a lender via Lendgo, a free platform that helps homeowners like you find reputable financial institutions to work with. In a matter of minutes, you could be reviewing the cash-out rates and terms that you qualify for!

When it comes to much-needed cash, act now while refinance rates are still low! Team up with Lendgo now and have a lump sum of cash in no time.