What’s the Difference Between a Refinance and a Cash-Out Refi?

What’s the Difference Between a Refinance and a Cash-Out Refi?

New York, December 28, 2021

iQuanti: Refinancing a mortgage is essentially replacing your current mortgage with a new one, often to take advantage of lower interest rates. A common reason for a cash-out mortgage refinance is to gain access to cash that can be used for improvements. The difference between a refinance and a cash-out refi is that in a cash-out refi, you take out a loan that is larger than your mortgage and have access to the difference in cash. 

Homeowners usually find a mortgage refinance from Discover or another lender to be a worthwhile option when doing so will help them save money in the long run and/or reduce their monthly bills. 

What is a cash-out refinance vs a home equity loan?

A cash-out refinance and a home equity loan have a number of similarities. Both loan types can be used to upgrade your home, use your home as collateral, and the amount you can borrow will depend on how much equity you have in your home. 

Cash-out refinance

A cash-out refinance replaces your current mortgage with a new one, giving the borrower a lump sum that’s larger than what they owe to pay off the remaining old mortgage and pocket the difference in cash. 

For example, let’s say the home is worth $200,000, you owe $100,000. You typically can only borrow up to 80% of your equity, and must leave 20% equity in the home, (in this case $40,000). You can then use $100,000 to pay off your old mortgage, and then you could have $60,000 remaining to take out as cash. You will need to account for any lender or closing fees that your lender may charge, though some lenders like Discover Home Loans have no appraisal, origination or cash due at closing. 

Many homeowners use this cash for renovations, but it can be used for virtually anything. 

Home Equity Loan

A home equity loan is often a second mortgage that does not necessarily replace your original mortgage, but rather it is an entirely separate loan that you can take out in addition to your first mortgage. The amount that you have access to in a home equity loan depends on how much equity you have.

For example if the home is worth $300,000 and you have 50% equity ($150,000 loan balance and $150,000 in equity), your home equity loan might be close to $90,000 (80% of your $150,000 equity). You would still have to pay off your mortgage AND you’d have the home equity loan to pay off as two separate debts, but that’s not necessarily a bad thing if you have a plan for paying them off and recouping the costs. 

For instance, you might use a home equity loan to consolidate other debts, like credit card debt and student loans, and pay them off as one debt, gradually with a lower interest rate. 

Refinancing might be worthwhile if …

• You plan to spend enough time in your home to recoup the costs of refinancing. This depends on the terms of your mortgage and how you’re planning to refinance — you can do the math easily with a refinance calculator online.
  
  
• The renovations will significantly improve the value of your home.
  
  
• You’ve built up a significant amount of equity in your home.
  
  
• You plan to use the loan to improve your home and the expenses may be tax deductible. (The tax rules vary depending on your particular circumstances. Consult your tax advisor for more information.)
  
  
• The closing costs do not exceed the money you would potentially save on lower interest rates.
  
  
• The differences in monthly payments and loan terms are manageable for you. Always remember that new loans come with new terms.

The bottom line

Refinancing can be worthwhile for homeowners who plan to remain in the home long enough to recoup the costs. Other major factors to consider are interest rates and if the changes in your monthly payments and loan terms would be favorable. A cash-out refinance is generally a good option for making home improvements or for when you need access to a large amount of cash, and the interest rate is low enough to make the loan worthwhile. Consider how much cash you need and what you’ll be paying to borrow it, and if selling your improved home will help you recoup those costs.