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Cash-out refinance vs home equity loan: The better deal might surprise you

Gina Pogol
The Mortgage Reports contributor

Cash-out refinances make no sense — except for you

With the majority of homeowners in the US happily sitting on mortgage interest rates between three and five percent, why on earth would anyone ever consider a cash-out refinance to get extra money?

According to mortgage software firm Ellie Mae, mortgage borrowers were getting an average rate of 5.01% as of January 2019. So why would applicants request a replacement mortgage at a potentially higher rate?

In addition, there may be significant closing costs involved.

This reason: A cash-out refinance may still be your cheapest and best option when you need big money.

Verify your FHA cash out refinance eligibility. (Sep 22nd, 2019)

How to choose a cash-out refinance or home equity loan

The best option for you depends on several factors:

  • How much money do you need?
  • How much equity do you have?
  • What’s your time frame for repayment?
  • What’s your tax pro say?
  • How much are you risking?

Here are several examples of cash-out mortgage decisions, so you can get a feel for the way real situations work.

Cash-out refinance for a small home repair

Mrs. Etheridge, a retiree, owns a house worth about $400,000. She owes $200,000 and needs about $25,000 to make some needed repairs. Her current mortgage is a 30-year fixed loan at 4.5 percent. She’s being offered about 5 percent today for a cash-out mortgage.

The added payment for the extra $25,000 over 30 years is about $135 a month.

And, she’ll pay a cash-out surcharge upfront of around  .375 percent ($840). This is a relatively low amount because her balance is so low (less than 60 percent of her home vale) and her credit is excellent.

In addition, she’ll spend about $1,000 on title and escrow fees, plus another $1,000 on loan origination and processing charges from the lender.

In all, it’s costing about $3,000 upfront to access $25,000. This is a 12% hit. Not a great deal, but not the end of the world.

A better alternative might be a personal loan, where should could borrow $25,000 quickly, easily, and with very little cost. She wouldn’t have to touch her first mortgage or reset her loan term.

Check my eligibility & rate for a personal loan up to $100k * (Sep 22nd, 2019)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV

Lower credit means higher expense for cash-out loans

But what if Mrs. Etheridge has less equity and worse credit?

That cash-out surcharge could balloon to over three percent ($7,300, which is 30 percent of the money she wanted for her repairs!).  Add in the lender charges and title/escrow fees, and her loan costs could swell to about half of the amount she wanted to borrow.

She’d be better off putting it on a credit card, taking a personal loan, or (best deal) choosing a home equity loan or HELOC with a lower rate and few to no costs.

When the cash-out refinance makes sense

In general, the more cash you need, the more likely it is that this option is viable.

For instance, suppose Mrs. Etheridge owes just $200,000 on her $400,000 house and wants another $100,000 for a major home addition. She still gets the .375% surcharge for cash-out, which is $750. She still has the title and lender charges — approximately another $2,000. But these fees come to just 3 percent of the amount she wants to borrow.

The added payment for $100,000 at 5 percent is $535 a month.

On the other hand, a $100,000 loan at the typical home equity rate and term (7.5 percent and 15 years), increases her monthly expenses by $700.

If you’re on a tight budget, that’s a major consideration.

The chart below shows instances in which it makes sense to choose a cash-out refinance mortgage. This assumes you have a lower current first mortgage rate than is available now.

Smaller cash-out transactions

Cash-out Refi Home Equity Loan
Current Loan $200,000 $200,000
New 1st Mortgage Rate 5% 4.5%
1st Mortgage Payment $1,075 $1,015
Additional Cash $25,000 $25,000
Rate for Additional Cash 5% 7.5%
Payment for Additional Cash $135 $175
New Total Payment $1,210 $1,190
Total Fees $3,000 $500

Larger cash-out transactions

Cash-out Refi Home Equity Loan
Current Loan $200,000 $200,000
New 1st Mortgage Rate 5% 4.5%
1st Mortgage Payment $1,075 $1,015
Additional Cash $100,000 $100,000
Rate for Additional Cash 5% 7.5%
Payment for Additional Cash $535 $700
New Total Payment $1,610 $1,715
Total Fees $3,000 $500

The rule of thumb: the more cash you need, the more attractive a cash-out refinance might be.

Lower rate or payment

If your credit has improved, your home equity has increased, or you’ve just become better at shopping for mortgages, you might be able to get the cash you need and a lower interest rate.

Your payment might even drop as well — especially if you use your cash out to get rid of higher-interest accounts like credit card debt.

Keep in mind that not only does your mortgage rate drop when your profile improves, so does your mortgage insurance (if you can’t get rid of it altogether).

If you can get a better mortgage than the one you have now, and procure the cash out you need, that’s kind of a no-brainer. Get your cash-out loan.

Other reasons to cash-out your home

If you have an FHA home loan or are paying any kind of mortgage insurance, getting a cash-out loan could actually reduce your payment.

If you have, say 30-40% equity, you could take cash out and still have 20% equity in the home — the point at which you no longer need PMI.

The math is easy. If you’re paying $200 in mortgage insurance and your principal and interest payment rises by the same amount, you get cash out with no additional monthly cost.

Alternatives to a cash-out refinance

Cash-out loans have their place, but there are two options that are faster, cheaper, and easier than getting a whole new first mortgage.

1. Use a personal loan for smaller, quicker, and cheaper cash

Personal loans don’t come with all the costs of a traditional mortgage. There are no title, escrow, or appraisal fees. The property doesn’t matter at all.

The loan is based on your credit and income history, not the house. That eliminates time and expense getting these loans.

If you want quick cash below $50,000 (or maybe even more), your best bet might be a personal loan.

Check my eligibility & rate for a personal loan up to $100k * (Sep 22nd, 2019)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV

2. Home equity loans are cheaper than full refinances

Typically, home equity loans and lines come with higher interest rates than cash-out refinances. They also tend to have much lower closing costs. So if a new mortgage rate is similar to your current rate, and you don’t want to borrow a lot of extra cash, a home equity loan is probably your best bet.

Second mortgage (home equity) rates run between five and ten percent for most borrowers (with terms of 15 years), and closing costs are probably very low or even totally absorbed by the lender.

So Mrs. Etheridge might get a 7.5 percent rate on her $25,000 repair loan with a home equity loan. Note, though, that the payment would be higher because of the shorter repayment period.

The “blended rate” calculation

One way consumers can determine if it’s better to get a cash-out refi or add a home equity loan is called the “blended rate.” The worksheet below shows how this works.

How to Calculate a Blended Rate
Rate Amount Portion of Total Weighted Rate (Rate * Portion)
Loan 1 6%  $      100,000 67% 3.67%
Loan 2 8%  $        50,000 33% 2.67%
Total  $      150,000 100% 6.33%

In this case, the blended rate is 6.33 percent.

Where do I apply for a cash-out loan?

Current cash-out mortgage rates today might be better than you think. Especially if your credit or equity has improved in the last couple of years. Check with several mortgage lenders and see if you can do better than you are now.

Get started on your cash-out refinance here. (Sep 22nd, 2019)