Need to Take Cash Out of Your Home? Here's Why a Home Equity Loan Makes More Sense Than a Cash-Out Refinance Today

It all boils down to the amount you're borrowing.

One huge benefit of owning a home is getting to tap the equity you build in it. Home equity is defined as the value of your home minus what you owe on your mortgage. If your home could sell for $400,000 and you owe $200,000 on your mortgage, you're left with $200,000 in equity. And that equity is something you can borrow against in different ways.

Meanwhile, homeowners today are sitting on lots of equity thanks to the explosive housing market we've seen over the past few years. According to CoreLogic's most recent home equity analysis, U.S. homeowners with mortgages saw their collective equity increase by more than $2.2 trillion between the third quarter of 2021 and the third quarter of 2022. That's an annual gain of 15.8%.

When it comes to tapping your home equity, you could do so via a cash-out refinance or a home equity loan. But the latter may be a better choice today for one big reason.

When borrowing rates are up, it pays to borrow less

These days, borrowing rates are up across the board. It's more expensive than it was a year ago to refinance a mortgage, finance a car, take out a personal loan, or put a home equity loan into place.

But the reason a home equity loan is generally a better bet than a cash-out refinance today is that with the former, you're borrowing less money. And when interest rates are elevated, it pays to keep the sum you borrow to a minimum.

Let's say you need $50,000 to do a major home remodel and you owe $200,000 on your mortgage, but also have $200,000 in equity. You could most likely qualify for a $250,000 cash-out refinance pretty easily, assuming there aren't major issues with your credit score. But in that case, you're taking out a $250,000 loan that you'll probably get stuck with a not-so-competitive interest rate on.

On the other hand, if you take out a $50,000 home equity loan to fund your renovation, you're only borrowing $50,000. You're not borrowing that money plus the entire balance of your mortgage.

Plus, if you currently have a fairly low interest rate on your mortgage, the last thing you'd want to do is increase it substantially by refinancing. So if that's the case, you're better off taking cash out of your home by going the home equity loan route.

It pays to shop around

Borrowing rates may be up across the board right now, but that doesn't mean you should resign yourself to getting stuck paying a lot of interest. Before you sign a home equity loan, shop around with different lenders to see which one has the best offer.

At the same time, because rates are up, it pays to try to keep your borrowing to a minimum. If you only need $50,000 for your upcoming renovation, don't borrow $60,000.

When rates are lower, it can make sense to tack extra money onto an existing loan so you have a little more borrowing leeway. But since that's far from the case today, you're probably better off only borrowing what you need.