When is a home equity loan cheaper than a cash-out refinance, and when isn't it?

Summary

A home equity loan is cheaper whenever your current mortgage rate is well below today's rates, because a cash-out refinance moves the whole existing balance to the new rate, not just the cash you take out. In the example below, that costs about $48,000 more interest over five years. The two routes only come out even when the old mortgage's rate is about as high as the new one.

What actually gets repriced

The CFPB describes a cash-out refinance this way: "you replace your existing mortgage with a bigger mortgage and take the difference in cash." A home equity loan leaves the first mortgage alone and adds a second loan on top.

That difference sounds technical until you put numbers on it. Say the house is valued at $500,000 and you owe $250,000 at 3.5% with 25 years left, a payment of $1,251.56. You need $50,000.

Keep the mortgage and add a home equity loan on Regions Bank's published example (10 years, 6.75% APR) and you pay $574.12 more a month, $1,825.68 in total. Over five years that is $54,509 in interest across both loans, and you still owe $244,969.

Refinance into a new $300,000 30-year loan at 7.03%, the 30-year average in Freddie Mac's weekly survey when this was written, and the payment is $2,001.96. Over five years you pay $102,602 in interest and still owe $282,485.

The $50,000 is the same in both cases. The extra $48,000 of interest comes from the $250,000 that went from 3.5% to 7.03%. A 15-year refinance at the survey's 6.42% average cuts the five-year interest to about $85,800, but raises the payment to $2,600.15.

Closing costs are left out of these figures, and they point the same way. Regions says "Bank pays all closing costs" on its home equity loan, while the CFPB says of cash-out refinancing, "Often, you have to pay closing costs."

When the old rate is high

Change one input: make the existing mortgage 7.5% instead of 3.5%. Keeping it and adding the home equity loan now costs $103,795 in interest over five years, against $102,602 for the refinance. The monthly payment flips too. Keeping the old loan costs $2,421.60 a month, while the refinance, which restarts the clock at 30 years, costs $2,001.96.

The CFPB's own advice points at the same variable: "Carefully consider the interest rate, especially if it is higher than the interest rate on your current mortgage." It also says that "depending on the terms a cash out refinance may be more or less expensive than a HELOC."

How much cash a refinance can release

Fannie Mae's Eligibility Matrix caps a cash-out refinance on a one-unit principal residence at 80% loan-to-value. On a $500,000 house that is a $400,000 loan, so with $250,000 owed, the most you could take out is $150,000 before costs.

The Selling Guide adds two timing rules. An existing first mortgage being paid off "must be at least 12 months old at the time of refinance," and one or more borrowers need six months on title before the new loan funds. Someone who bought with a mortgage less than a year ago can't use this route under these rules.

Home equity lenders set their own caps. Regions lists 85% as its maximum loan-to-value for a second mortgage on a primary residence.

Sources

Written by Kaz (pen name). Figures are copied from providers' published pages on the dates shown. We have not used these products. Corrections: contact form.