If you'd like to convert some of your home equity into cash, you have several choices.
- You can replace your current mortgage with a cash-out refinance.
- You can take out a home equity loan or line of credit.
- Or you can refinance to a lower payment and direct the extra cash flow to your project.
Which option is best? That depends on several parameters.
- How much more does a cash-out refinance cost than a regular rate-and-term refinance?
- How much money do you need?
- Do you need a lump sum or a steady stream of income?
- Is the interest rate more important to you than the payment amount?
- How much home equity do you have?
Here is how one hypothetical homeowner might make the decision.
- Home is worth $300,000
- Mortgage balance is $180,000 (he has $120,000 in home equity)
- Current mortgage rate is 4.25 percent
- He needs $25,000 for debt consolidation
- He plans to keep his home for the foreseeable future.
Harry checks out LendingTree's Loan Explorer and discovers that he can get a regular 30-year fixed mortgage of 4.089 percent, but if he wants a cash-out refinance, the APR increases to 4.30 percent. He also qualifies for a 15-year home equity loan at a rate of 5.8 percent. How can he compare these two options? By calculating what's called a blended rate for the combination of first mortgage refinancing plus a home equity loan and comparing it to the rate for the cash-out refinance. Here's how that works.
First, determine the proportion of first mortgage and second mortgage to the total borrowed.
$180,000 + $25,000 = $205,000 $180,000 / $205,000 = 88 percent $25,000 / $205,000 = 12 percent
Next, multiply the percentage of the total borrowed by the interest rate for each loan.
4.089% * .88 = 3.598% 5.80% * .12 = .696%
3.598 + .696 = 4.294 percent, which is less than the rate for a cash-out mortgage.
Add the above-listed rates together to create a weighted average of the interest rates. That's your blended rate. Keep in mind, however, that the home equity loan has a 15-year term, not a 30-year term. That will do two things -- cause him to pay less interest over the life of the loan because the home equity balance will be paid off twice as fast, but also cause him to have a higher monthly payment. So if the monthly payment is more important than the interest rate, he might be better off with the cash-out refinance.
In general, if you need a relatively small amount of cash, the home equity loan is likely to be a cheaper choice. Home equity loans come with very low fees, and they only apply to the smaller loan balance, not your first mortgage. Cash-out refinancing, on the other hand, is better when you need a larger amount of money. Here's how Harry's options change when he wants $100,000 in cash instead of $25,000. When a greater proportion of borrowing is at the higher 5.80 percent rate, Harry's blended rate jumps to 4.70 percent, which is higher than the cash-out APR of 4.3 percent.