Before You Take Out a Home Equity Loan, Consider This

by Maurie Backman | Published on Aug. 30, 2021

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Home equity loans are affordable and convenient, but there may be an even better way for you to borrow money.

Whether you need money to pay for home renovations, a new vehicle, or another reason, if you have a lot of equity in your home, you might consider getting a home equity loan. With a home equity loan, you borrow a specific amount and pay it off over time. And generally, qualifying for a home equity loan is pretty easy as long as you have the equity in your property to back up your request.

Equity refers to the portion of your home you own outright. If your mortgage balance is $300,000 and your home could sell today for $400,000, that gives you $100,000 in equity. That $100,000 is something lenders will generally let you borrow against via a home equity loan. But before you take one out, here's another option worth looking at.

Should you do a cash-out refinance?

When you refinance a mortgage, you trade your existing loan for a new one with terms that work better for you, snagging a lower interest rate on your home loan. With a cash-out refinance, you borrow more than your existing mortgage balance and get to use the remaining cash payout for any purpose.

Like home equity loans, cash-out refinances hinge on you having enough equity in your property to qualify. But if you do have that equity, along with a strong credit score and a reasonable debt-to-income ratio, then it could pay to do a cash-out refinance the next time you need money.

With a cash-out refinance, you might pay less interest than what a home equity loan will charge you. This is especially true today, since refinance rates are sitting at very competitive levels across the board.

Also, if you do a cash-out refinance, you'll have the opportunity to lower the interest rate on your mortgage. And that, in turn, could result in serious savings, especially if you have many years left on your home loan. In fact, it may even be possible to do a cash-out refinance where you borrow more than your remaining mortgage balance but don't raise your monthly payments all that much -- or at all -- if you snag a low enough interest rate in the process.

Say you owe $300,000 on a 30-year fixed loan charging 4.5% interest. That means you'll be paying $1,520 a month for principal and interest.

If you refinance to a new $350,000 loan so you can pay off your $300,000 balance and get $50,000 in cash to use yourself, and you lock in an interest rate of 3.2% (which is roughly what the average refinance rate is today for a 30-year loan), your monthly payment will be $1,514. In other words, you'll effectively keep your monthly payment the same but get to borrow a lot more thanks to being able to snag a much lower interest rate on your loan.

Now one thing you should know is that the process of applying for and closing on a new mortgage can be lengthier than the process of getting a home equity loan. But it pays to deal with that one drawback if you have a need to borrow money due to the potential savings involved.

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