Home Equity vs. Refinance Calculator

For many American homeowners, their house is not just a place to live—it's also their most valuable asset and a potential source of funding for life's major expenses. When the need for substantial cash arises, whether for home improvements, debt consolidation, education costs, or other significant expenses, two common options emerge: tapping into home equity or refinancing the mortgage. Both approaches have distinct advantages and potential drawbacks, making the decision process a nuanced financial calculation.

Home equity loans and home equity lines of credit (HELOCs) allow homeowners to borrow against the equity they've built in their home without changing their original mortgage. This equity—the difference between your home's market value and what you owe on your mortgage—can be accessed while keeping your existing mortgage intact. On the other hand, cash-out refinancing involves replacing your current mortgage with a new, larger loan and taking the difference in cash.

The appeal of home equity loans lies in their simplicity and lower closing costs compared to refinancing. With a home equity loan, you receive a lump sum with a fixed interest rate and fixed monthly payments for a specified term. This predictability makes budgeting straightforward. Additionally, the application process is typically less complex than refinancing, and closing costs are generally lower, often ranging from 2% to 5% of the loan amount. For homeowners who already have favorable terms on their existing mortgage—particularly those who secured historically low interest rates in recent years—maintaining that original loan while adding a separate home equity product can be financially advantageous.

However, home equity loans typically come with higher interest rates than first mortgages because they represent a greater risk to lenders as second liens. These higher rates can make them less attractive for borrowing large amounts or for longer terms. Additionally, having two separate loans means juggling two monthly payments, which some homeowners may find inconvenient.

Cash-out refinancing, by contrast, creates a clean slate with a single, new mortgage that replaces your existing loan. This approach is particularly advantageous when current market interest rates are lower than your existing mortgage rate. By refinancing, you could potentially secure a lower interest rate on your entire mortgage balance, not just the additional funds you're borrowing. This can result in significant long-term savings, especially if you plan to stay in your home for many years. Refinancing also simplifies your financial life by consolidating your home-related debt into one monthly payment.

However, refinancing isn't without drawbacks. The closing costs are typically higher than those for home equity loans, often ranging from 2% to 6% of the loan amount. This means the break-even point—the time it takes for interest savings to exceed closing costs—can be several years away. If you plan to move before reaching this break-even point, refinancing might not be cost-effective. Additionally, refinancing resets the clock on your mortgage term. If you've already paid 10 years on a 30-year mortgage and then refinance into a new 30-year loan, you're extending the total time you'll be making mortgage payments, which could significantly increase the total interest paid over the lifetime of the loan.

Tax implications also differ between these options. Under the Tax Cuts and Jobs Act of 2017, interest on home equity borrowing is only tax-deductible if the funds are used for "buying, building, or substantially improving" the taxpayer's home that secures the loan. Interest from cash-out refinancing may have broader deductibility, but this can vary based on how the funds are used and the total loan amount relative to property value limits. Consulting with a tax professional before making a decision is always advisable.

Your personal financial situation should heavily influence your choice. Factors to consider include how long you plan to stay in your home, your current mortgage rate compared to prevailing market rates, the specific purpose of the funds, your credit score, income stability, and overall debt load. For instance, homeowners with excellent credit scores may qualify for the best rates on either option, while those with fair credit might face higher rate premiums on home equity products.

It's also worth considering the current economic climate and housing market trends. During periods of rising interest rates, those who secured mortgages at lower rates may prefer home equity loans to preserve their favorable first mortgage. Conversely, in declining rate environments, refinancing might offer compelling advantages. Additionally, in robust housing markets where home values are appreciating rapidly, leveraging increased equity can provide access to significant funds, but this should be approached cautiously to avoid overextending based on potentially temporary value increases.

The decision between a home equity loan and cash-out refinancing ultimately requires careful analysis of both immediate financial needs and long-term objectives. While home equity loans offer simplicity, lower closing costs, and the ability to preserve favorable terms on existing mortgages, cash-out refinancing can provide lower interest rates on the entire borrowed amount and the convenience of a single monthly payment. By thoroughly analyzing the costs, benefits, and alignment with personal financial goals, homeowners can make informed decisions that optimize their home's financial potential while maintaining long-term economic security.