Deciding between a cash-out refi or a home equity loan

You’ve worked hard to build up the equity in your home, and now you want to tap into it to make a big purchase or to renovate your home. You’ve got a few options, two of the most common being a home equity loan or line of credit and a cash-out mortgage refinance. But how do you choose which option is best for you?

First, the basics:

Home Equity loans. There are two types of home equity lending: a home equity loan and a home equity line of credit (HELOC). A home equity loan gives you a lump-sum payout, while a HELOC gives you a line of credit that you use as you need it, but that you don’t have to access all at once.
Pro tip: Alliant offers Interest-Only HELOCs for members who need funds over time and want to keep their payments lower now.

Cash-out refinance loans. With a cash-out refinance, you are basically taking out a larger mortgage and getting a cash payout for the amount your loan increases. For example, say your home is worth $400,000 and you currently owe $200,000 on your mortgage. If you need $100,000 for an addition to your home, you could do a cash-out refinance to get a new $300,000 mortgage and get the $100,000 in cash for your addition.

Is a cash-out refinance, a home equity loan or a HELOC right for you?

1. Are you paying a high mortgage rate now? If your mortgage interest rate is higher than today’s average rate, a cash-out refinance could be the way to go, regardless of how large or small your cash need is. By doing a cash-out refi, you’ll be able to reduce the interest rate you pay on your entire mortgage and get cash for your equity all in one process. Conversely, if you bought or refinanced when rates were at rock-bottom a few years ago and your new mortgage rate would be higher, refinancing your mortgage could cost you more over the years. 
   Pro tip: Be sure to factor in closing costs when you calculate what you’ll save by refinancing. If your closing costs will be more than you’ll save, you might be better off with a HELOC from a lender like Alliant that doesn’t charge any application fees or closing costs for home equity loans.
2. Do you need the money quickly? If so, a cash-out refinance is not a good fit, because you’ll have to go through a full mortgage approval process, which takes much longer than the home equity loan process.
   Pro tip: If you need cash urgently, an unsecured personal loan could be a good fit. They are often reviewed and approved within a day or two, so you could get cash very quickly, especially if you have good credit.
3. Do you need the money all at once, or will you be using it a little bit at a time? If you need a large, lump-sum payout, a traditional home equity loan or a cash-out refinance could work for you, as you’ll receive a one-time payout of the full loan amount. If your expenses will be spread out – you have several small home-improvement projects over a span of time or have ongoing medical expenses, for example –  a HELOC might be a better fit. With a HELOC, you use it as you need to, for only the amount you need right then.
4. How much equity do you have in your home? The amount of money you can get from your home depends largely on your equity as expressed via a loan-to-value ratio or LTV. In simple terms, LTV is equivalent to the percentage of your home’s value that you still owe: If you owe $400,000 on a $500,000 home, your LTV is 80. Financial institutions generally have different LTV thresholds for their home equity and cash-out refinance loans, and those thresholds may limit your loan options.
5. How much money do you need? If you only need $10,000 for a repair or remodel project, a cash-out refinance may not be a good fit, because the closing costs associated with refinancing your mortgage would represent a significant chunk of that loan amount. On the other hand, if you’re adding onto your home to create a family room and master bedroom and bathroom suite that will cost $150,000, closing costs would be a small portion of that expense.

Deductibility of cash-out refis or home equity loans

The tax reform law passed in December made changes to the deductibility of mortgage interest, but not to the extent that many people think. The interest on a new home equity loan, HELOC or cash-out refinance loan may still be deductible for you. (Note: Every person’s tax situation is different and I am not a tax professional, so before you make a decision, you should talk to your tax advisor!)

Generally, if the money you’re borrowing is used for home improvements, the interest may still be deductible, but there are new dollar limits to how much of a deduction you can claim, so consult your tax attorney before you make any decisions based on tax deductibility.

Our best tip: Talk to the pros!

You may be thinking that I sound like a broken record by saying again that you should consult with experts, but there’s a reason for that: The above considerations and their many variables are very complicated. So before you pull the trigger on either loan type, you should talk to a mortgage pro and your tax advisor to confirm how each option will affect you in terms of your payments and the deductibility of the interest you pay.