It’s the age old dilemma. Cash-out refinance or home equity loan – which one should you use to pay off your debt?

First of all, if you need cash you probably want it pretty fast. Technology has made that extremely possible in this day and age of instant financial transactions and online purchasing.

Second, you have equity in your home because you bought wisely, spent a little bit to update your “castle” and now it’s worth more than you owe. That was smart of you. Good job!

Third, you want to borrow at a low rate and you want the possibility of tax-deductible interest. Who doesn’t, right?

So, you investigate and compare a cash-out refinance against an old-fashioned home equity loan or line of credit. Without getting into too many specifics here, more often than not, a cash-out refinance will cost less and make more financial sense (keep in mind, lots of stuff influences final mortgage numbers so you’ll need to have a mortgage professional review your situation to make absolutely sure).

Here’s why.

Why choose a Cash-Out Refinance?

A home equity loan or home equity line of credit are usually second mortgages. In other words, they are mortgages that you take out on top of the first, or main, mortgage that you have on your home. This makes them second liens against your property and therefore they are more risky and expensive for both you and your mortgage company. A cash-out refinance is not a second loan; it is a new first mortgage.

The purpose is to completely pay off the original mortgage, and borrow a set amount of money against the remaining equity in your home. It’s less risky and cheaper because it’s a first mortgage, not a second. With few exceptions, the rates on cash-out refinances are almost always lower than home equity loans or home equity lines of credit. There may be more closings costs with a cash-out refinance, but usually these are made up in the long run with lower monthly interest payments.

Here’s a simple example of how it works:

How a Cash-Out Refinance Works

Let’s say, for simplicities sake, you have a $100,000 mortgage balance on a home worth $150,000. Your daughter wants to go to college to pursue her education dreams and you decide to borrow $25,000 to help pay expenses. With a cash-out refinance, you would simply get a cash-out refinance mortgage on your home for $125,000 (well under the appraised price of $150,000) and $25,000 more than you currently owe. With this scenario, $100,000 would go to your original mortgage holder to completely pay off your mortgage. The remaining $25,000 would go to you to use as you please (in this case helping your daughter with her college expenses).

Going forward, you would only have one payment on your new $125,000 refinanced mortgage, with interest tax-deductible (in most cases). Make sure you check with a professional tax advisor before you deduct anything when you do your taxes. We hate saying “we told you so” and we may just do that if you deduct from your income on your taxes without knowing if you should or can.

In the end, it’s really up to you whether you go with a cash-out refinance or a home equity loan or home equity line of credit. All three have advantages and disadvantages, some just more than others. In the current mortgage and real estate market, in most cases, a cash-out refinance most likely is in your best financial interest, but check with our mortgage banker and go over all your options before you make any decisions.

That’s always your best bet!