If you're a homeowner, you may have noticed that your home equity is continuing to increase. This change can be a good thing because it gives you more financial flexibility and options for the future. There are two primary ways to access this extra money: a home equity loan or a cash-out refinance mortgage.
In terms of interest rates, home equity loans tend to be higher than mortgages. However, they also have lower closing costs and fees. And some home equity lenders may offer waivers of some or all of these fees as an incentive for borrowers.
- Home equity loans can help finance home renovation projects, a child's college education, medical bills, and more.
- Mortgages can purchase homes, but cash-out refinance mortgages can give you a lump sum of cash to use for expenses.
- Home equity loans usually have higher rates than mortgages, but lower fees and closing costs.
- Some home equity loan lenders do waive origination and appraisal fees, so it's worth shopping around.
How Do Home Equity Loans Differ From Mortgages?
Home equity loans and cash-out refinance loans are both tools you can use to get large amounts of cash for home repairs or other major expenses.
A home equity loan, sometimes called a second mortgage, allows you to borrow against the equity you established in your home: the current value of your house minus what you owe on your existing mortgage.
By contrast, a cash-out refinance loan is a type of mortgage. With this approach, you take out a new mortgage for a larger amount than you currently owe. The lender issues you the difference in cash to use as you like.
When deciding which is best for you, consider the following factors:
APR: In general, mortgages have lower annual percentage rates (APRs) than home equity loans do. However, your rate is dependent on several things, including your credit score and income.
Amount needed: Mortgage loans may give you a larger amount of money than home equity loans. Some lenders offer 125% cash-out refinance loans, allowing you to borrow up to 125% of your home's value. By contrast, home equity loans are generally limited to 80% of your home's equity.
Repayment term: A cash-out refinance is basically a whole new mortgage, so repayment terms can range from 15 to 30 years. With a home equity loan, you generally have five to 15 years.
Typical Cash-Out Refinance Mortgage Fees
When it comes to mortgage fees, cash-out refinance mortgages tend to have higher costs than home equity loans. This is because they are essentially a brand new mortgage, so lenders must go through the entire origination process with you—including ordering a new appraisal and title search.
Typical fees charged for a cash-out refinance mortgage include:
- Origination fee: Lenders charge origination fees to cover processing your loan application.
- Appraisal fee: This fee covers the cost of having an appraiser review your house's value.
- Credit report fee: Some lenders charge a fee to pull your credit report as part of the loan application process.
- Lender origination fee: This is a fee charged by the lender for originating, or creating, your loan.
- Title services: You'll likely need to pay for a title search and insurance as part of your cash-out refinance mortgage.
- Survey fee: A survey fee is sometimes required to confirm the boundaries of your property.
- Attorney fees: If you live in a state that requires the use of an attorney for real estate transactions, you'll need to pay their fees as part of your cash-out refinance.
All told, closing costs on a cash-out refinance typically total 2% to 5% of your loan amount. The costs are calculated on the entire loan amount, not just the additional balance you’re adding to the mortgage.
For example, let’s say you own a home worth $300,000 and owe $200,000 on your existing mortgage. If you take out a cash-out refinance loan for $240,000 with 3% closing costs, you’d pay an additional $7,200.
There are some lenders that offer cash-out refinance mortgages with no closing costs, but you may have to pay a higher rate for that option.
Typical Home Equity Loan Fees
In general, home equity loans have higher APRs than mortgages, but they may have lower fees. Fees are usually 2% to 5% of your loan amount and cover:
- Origination fees
- Appraisal fees
- Credit report fees
- Title fees
- Document and filing fees
- Insurance costs
Though that’s the same range as cash-out refinance mortgages, keep in mind that home equity loans are usually for smaller amounts than cash-out refinance loans because you’re borrowing against your home’s established equity.
For example, say you have a home worth $300,000 and owe $200,000 on your existing mortgage. If you take out a $40,000 home equity loan that charges 3% in closing costs, your cost would be just $1,200—substantially lower than if you used a cash-out refinance loan to get a $40,000 lump sum.
As with mortgages, there are some lenders that will waive origination or appraisal fees, so it’s a good idea to shop around with different lenders.
What if My Cash Needs Are Somewhat Unpredictable?
If you think you may need continual access to cash, a home equity line of credit (HELOC) may be a better choice for you. HELOCs are revolving lines of credit, so you can use the money again and again during the draw period, and you only pay interest on the amount you use.
For What Do Most People Use Home Equity?
The most common reason people borrow against their home equity is to pay for home improvements, including kitchen remodeling and bathroom updates.
Are There Risks to Using Your Home as Collateral?
Yes. Home equity lenders place a second lien on your home, giving them the rights to your home along with the first mortgage lien if you fail to make payments. The more you borrow against your house or condo, the more you put yourself at risk.
The Bottom Line
Home equity loans and cash-out refinance mortgages are popular ways to access cash. However, loan options charge various fees. Home equity loans usually have lower fees than mortgages do, but they may have higher APRs.
Before choosing a loan and submitting a loan application, research your financing options. Depending on your needs, alternatives like personal loans or a 0% APR credit card may be a better option. If you do decide to take out a loan, compare rates from multiple lenders so you can find the best deal.