Home Equity Loan vs Cash Out Refinance: What You Should Know

Home equity loan and cash-out refinance refer to two popular financial options homeowners use to tap into the equity they’ve built in their homes. When comparing a home equity loan and a cash-out refinance, it’s essential to consider how each option works, especially if you want to finance a project such as a home renovation. 

Home Equity Loan: What You Need to Know

A home equity loan allows you to borrow against the equity you’ve built in your home. It’s disbursed as a lump sum and typically has a fixed interest rate. This means predictable monthly payments over the life of the loan, which is appealing to homeowners who prefer stability in their repayment schedule. 

The downside of home equity loans is that they often come with slightly higher interest rates compared to cash-out refinances because they take a second lien position. This means that if you default, the primary mortgage lender is paid first.

Benefits of Home Equity Loans

Some of the perks of home equity loans include: 

• Fixed interest rate: If you need a predictable way to manage long-term debt, this is a good option.
• No refinancing required: You do not need to refinance your first mortgage. This means you can hold onto your current interest rate, especially if it’s favorable.
• Lower upfront costs: Some lenders offer low or no closing costs, which makes home equity loans cheaper upfront than cash refinancing.

Drawbacks of Home Equity Loans

• Higher interest rates: Compared to cash-out refinance, the rates on home equity loans are generally higher.
• Risk of foreclosure: Like all secured loans, failing to meet payments can put your home at risk.

Cash Out Refinance: What to Consider

With a cash out refinance, you replace your current mortgage with a new, larger one and pocket the difference in cash. This can be a great option if interest rates have dropped since you took out your original mortgage, as it may allow you to lock in a lower rate while accessing extra funds.

Benefits of Cash Out Refinance

• Lower interest rates: With cash-out refinance, you can take advantage of essentially lower rates.
• Streamlined payments: No more multiple loan payments. A cash-out refinance lets you consolidate everything into a single mortgage with one monthly payment.

Drawbacks of Cash Out Refinance

• Higher upfront costs: Closing costs for cash-out refinances can range from 2% to 6% of the loan amount, making them more expensive upfront than home equity loans.
• Losing your current rate: If mortgage rates have risen since you took out your initial loan, refinancing could mean giving up a low interest rate.

Key Considerations When Choosing Between the Two

Here’s what to consider when choosing between a home equity loan and a cash out refinance:

1. Interest Rates: If you can secure a significantly lower rate through refinancing, a cash out refinance might be the better option. However, if your current mortgage has a great rate, sticking with it and taking a home equity loan could save money in the long run.
2. Closing Costs: While both options have closing costs, a cash out refinances come with higher upfront fees. However, depending on the lender, a home equity loan might offer lower closing costs or none.
3. Loan Purpose: If you’re looking for a one-time lump sum to consolidate debt or pay for a major renovation, a home equity loan may be more appropriate. On the other hand, a cash out refinance could be beneficial if you want to access a large amount of equity and possibly get a lower interest rate.
4. Existing Mortgage Situation: If you’re happy with your current mortgage rate, a home equity loan lets you borrow without changing your primary mortgage. On the other hand, a cash out refinance replaces your existing loan, so you could lose a favorable rate.

The Problem With Traditional Financing for Renovations

While traditional home equity loans and cash out refinances are valuable tools, they have limitations, particularly when funding home renovations. Both options rely on your current home equity, meaning your borrowing power is limited if you haven’t built up significant equity in the property. 

Additionally, cash out refinancing can potentially lock you into higher interest rates, especially if mortgage rates have increased since your original loan.

RenoFi Loans: A Smart Alternative

For homeowners looking to renovate, RenoFi loans offer a powerful alternative. Traditional home equity loans only allow you to borrow based on your current home value. In contrast, RenoFi loans consider the after-renovation value of your home, significantly increasing your borrowing power. 

Let’s walk through a couple examples where you want to spend $150,000 to renovate your new home and increase the value of your home by $150,000:

Scenario 1 (New Home Purchase): 

• Home price: $600,000
• Downpayment (20%): $120,000
• Current Mortgage Amount: $480,000

Example Home Equity Loan / Cash Out Refinance Amount: 

• $600,000 * 80% = $480,000 (80% of Total Home Value)
• $480,000 - $480,000 (Current Mortgage Balance) = $0 (Home Equity Loan / Cash Out Refinance Amount)

Example RenoFi Home Equity Loan / Cash Out Refinance Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $480,000 = $195,000 (RenoFi Home Equity Loan / Cash Out Refinance Amount)

Using a RenoFi Home Equity Loan or RenoFi Cash Out Refinance you have increased your loan amount from $0 to $195,000. Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $195,000 because the RenoFi loan is written against your ARV (After Renovation Value).

Without RenoFi loans, you would not have been able to borrow the $150,000 needed to add the renovations that would increase the value of your home by $150,000. Now, with RenoFi loans, you are now able to get the loan you need to add the renovations you want to your home.

Note that loan amounts for Home Equity Loans and Cash Out Refinance are calculated relatively similarly based on the % of Total Home Value, but differ in implementation of the loan product as stated above.

Scenario 2 (Recent Home Purchase): Assuming that you have now paid 10% of your mortgage:

• Home price: $600,000
• Current Mortgage Amount: $420,000

Example Home Equity Loan / Cash Out Refinance Amount: 

• Example Home Equity Loan / Cash Out Refinance % of Home Price: 80%

• Example Home Equity Loan / Cash Out Refinance Amount: 

  • $600,000 * 80% = $480,000 (80% of Total Home Value)
  • $480,000 - $420,000 (Current Mortgage Balance) = $60,000 (Home Equity Loan / Cash Out Refinance Amount)

Example RenoFi Home Equity Loan / Cash Out Refinance Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $420,000 = $255,000 (RenoFi Home Equity Loan / Cash Out Refinance Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $60,000 to $255,000 (4.25x more). Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $255,000 because the RenoFi loan is written against your ARV (After Renovation Value). 

Here’s a summary of the difference between traditional and RenoFi home loans in table form: 

In addition to letting you borrow more money for your home renovations, RenoFi loans also offer:

• No draw periods
• No inspections
• No need to give up your original loan
• Higher borrowing limits

RenoFi loans are funded on the day the loan is closed and that is it. Take out the $195k and you get $195k in your bank and you have 20 years to pay off in equal monthly payments with interest and principal, just like a standard mortgage.

Which Loan Is Right for You?

If you’re considering a home renovation, RenoFi loans are often the best choice. Traditional home equity loans and cash-out refinances can be helpful, but they come with limitations, particularly in terms of borrowing power and interest rates.

On the other hand, RenoFi loans give you the flexibility and financial power you need to make your dream renovation a reality without losing your current mortgage terms.

Whether you’re planning to remodel your kitchen, add an ADU, or completely transform your home, RenoFi loans offer unmatched benefits. By using your home’s future value, RenoFi provides homeowners with a more innovative, flexible way to finance renovations.

Renovate Smarter With RenoFi

While both home equity loans and cash-out refinances have advantages, RenoFi loans are the superior option for financing major renovations. With RenoFi, you don’t have to sacrifice your current mortgage rate or settle for insufficient funds. By borrowing based on your home’s future value, RenoFi loans give you access to the financing you need to complete any renovation project.

This makes RenoFi loans stand out from traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate. With RenoFi loans, you can borrow, on average, 11x more, get a low monthly payment, and keep your low rate on your first mortgage.

Start planning your renovation and discover how much you can borrow with a RenoFi loan. Learn more here.