Cash-out Refinance or Home Equity Loan? Here's How to Choose

If you'd like to convert some of your home equity into cash, you have several choices.

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.

Harry Homeowner

  • 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.

Harry Homeowner Cash Out Refi

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.

Get Home Equity Loan offers customized for you today.