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Mortgage Refinance Compared to a Home Equity Loan

Mortgage Refinance Compared to a Home Equity Loan

  • Options for Borrowers to Access the Equity in a Property
  • A cash-out refinance and debt consolidation refinance are ways for borrowers to access the equity in their property. A home equity loan or line of credit are other options for borrowers to access the equity in their property without refinancing their current mortgage.  There are multiple factors borrowers should consider when deciding between refinancing their mortgage or taking out a smaller home equity loan or line of credit.  In many cases a home equity loan or line of credit credit can save the borrower on up-front closing costs and total interest expense over the life of the loan.  Below, we outline the positives and negatives to each home financing approach and review examples that demonstrate when each option makes financial sense for borrowers.

    There are pros and cons to both financing options and the right answer depends on the borrower’s financial situation and objectives.  The key factors that determine if it makes sense to refinance or use a home equity loan or line of credit are the length of time you have been paying down your existing mortgage as well as the interest rates and terms of your existing mortgage and home equity loan or line of credit.  Closing costs are typically lower with a home equity loan or line of credit which is an added benefit but that should not be the determining factor in deciding what financing option is right for you.

    As we demonstrate in the first example below, in many situations it may not make sense to do a cash-out or debt consolidation refinance and instead it makes more financial sense to obtain a home equity loan or line of credit.  Unless you are able to reduce the interest rate and term of your existing mortgage by refinancing, it typically makes more sense for borrowers to select a home equity loan or line of credit, as long as you can access the amount of money need.  This is because by refinancing your existing mortgage, unless you reduce the term of the new mortgage, you are basically starting over in paying back the original mortgage, which will cost you thousands of dollars more in interest expense.  For example, if you are ten years into a $200,000 30 year mortgage and you refinance your mortgage with a new $200,000 30 year loan you have essentially converted your original 30 year mortgage into a 40 year mortgage, which means you pay thousands more in interest expense over the life of the loan.  The longer the mortgage the more interest expense you pay.

  • CalculatorUse our CASH-OUT REFINANCE CALCULATOR to determine if it makes sense to refinance your mortgage or use a home equity loan or line of credit
  • Example 1: Comparing a Home Equity Loan to a Refinance with No Reduction in Interest Rate or Term
  • The example below demonstrates how a home equity loan can save you hundreds of thousands of dollars in total interest expense as compared to a refinancing.  In this example the borrower is ten years into the original $300,000 mortgage and wants to access $50,000 in property equity for a major purchase.  The example compares two scenarios for accessing equity in a property: a home equity loan and a cash-out refinancing.  In the refinance scenario, the borrower does not reduce his or her mortgage term or interest rate by refinancing and replaces the original 30 year $300,000 mortgage with a new 30 year $300,000 mortgage.

    • Scenario 1: The borrower uses a 15 year $50,000 home equity loan and keeps the original mortgage in place
    • Scenario 2: The borrower uses a cash-out refinancing to access $50,000

    As demonstrated by this example, because the borrower does not reduce his or her mortgage term or interest rate by refinancing, the cash-out refinancing costs the borrower thousands more in total interest expense when you combine the original and new mortgages.  When you add the interest expense from the first ten years of the original mortgage to the new refinanced mortgage, the borrower spends $111,250 more in total interest expense as compared to keeping the original mortgage and taking out a home equity loan.  This is because the cash-out refinance effectively extends the term of the original mortgage by 10 years (so the borrower makes 10 extra years of mortgage payments in Scenario 2).  The total interest expense is greater in the refinancing scenario even though the interest rate on the new mortgage is less than the rate on the home equity loan.

  • Great Mortgage IdeaIf you are unable to reduce your interest rate or term by refinancing then a home equity loan or line of credit usually makes more financial sense

Scenario 1: Original Mortgage
Plus Home Equity Loan

Original
Mortgage
Home Equity Loan Total
Loan Amount $300,000 $50,000
Term 30 years 15 years
Current Principal Balance $244,000 $50,000
Interest Rate 5.00% 6.00%
Monthly Payment $1,610 $422 $2,032
Total Interest Expense $279,600 $25,950 $305,550

Scenario 2: Cash-Out Refinancing
No Reduced Term or Interest Rate

Cash Out
Refinancing
First 10 Years of
Original Mortgage
Total
Loan Amount $300,000
Term 30 years
Current Principal Balance $300,000
Interest Rate 5.00%
Monthly Payment $1,610 $1,610
Total Interest Expense $279,600 $137,200 $416,800
Total Interest Expense Savings / (Cost) ($111,250)
  • Example 2: Comparing a Home Equity Loan to a Refinance with a Reduction in Interest Rate or Term
  • The second example below demonstrates how a refinancing can save you thousands of dollars in total interest expense as compared to keeping your original mortgage and obtaining a home equity loan if you are able to reduce your interest rate and term when you refinance.  In this example the borrower is ten years into the original $300,000 mortgage and wants $50,000 for a major purchase.  This example also compares two scenarios for accessing equity in a property: a home equity loan and a cash-out refinancing.  In this example, however, in the refinance scenario the borrower replaces the original 30 year $300,000 mortgage with a 5.00% interest rate with a new 20 year $300,000 mortgage with a 4.00% interest rate.

    • Scenario 1: The borrower uses a 15 year $50,000 home equity loan and keeps the original mortgage in place
    • Scenario 2: The borrower uses a cash-out refinancing to access $50,000 and reduces both the interest rate and term of the mortgage

    As demonstrated by this example, because the borrower reduces his or her mortgage term and interest rate, the refinancing saves the borrower thousands in total interest expense.  When you add the interest expense from the first ten years of the original mortgage to the new refinanced mortgage, the borrower saves $32,050 in total interest expense as compared to keeping the original mortgage and taking out a home equity loan.

  • Great Mortgage IdeaAlways remember to consider total interest expense when evaluating if you should refinance or obtain a home equity loan or line of credit
  • Because the mortgage term was reduced from 30 years to 20 years, the borrower’s monthly mortgage payment increases from $1,610 with the original mortgage to $1,818 with the new refinanced mortgage even though the mortgage amount stayed the same and the interest rate decreased.  The shorter the mortgage term, the higher the monthly mortgage payment but the lower the total interest expense over the life of the mortgage.  Despite the increase, the new monthly mortgage payment of $1,818 is less than the $2,032 combined monthly payment of the original mortgage ($1,610) and the home equity loan ($422).

  • Great Mortgage IdeaIf you are also able to reduce your interest rate and term, refinancing can save you money in total interest expense as compared to a home equity loan or line of credit

Scenario 1: Original Mortgage
Plus Home Equity Loan

Original
Mortgage
Home Equity Loan Total
Loan Amount $300,000 $50,000
Term 30 years 15 years
Current Principal Balance $244,000 $50,000
Interest Rate 5.00% 6.00%
Monthly Payment $1,610 $422 $2,032
Total Interest Expense $279,600 $25,950 $305,550

Scenario 2: Cash-Out Refinancing
Reduced Term AND Interest Rate

Cash Out
Refinancing
First 10 Years of
Original Mortgage
Total
Loan Amount $300,000
Term 20 years
Current Principal Balance $244,000
Interest Rate 4.00%
Monthly Payment $1,818 $1,818
Total Interest Expense $136,300 $137,200 $273,500
Total Interest Expense Savings / (Cost) $32,050

    As demonstrated by Example #1, when comparing a refinancing to keeping your original mortgage and using a home equity loan or line of credit there may be a trade-off between having a higher monthly payment for a set number of years (10 to 15 years for a home equity loan) and paying less in total interest over the life of the mortgage.  In an ideal scenario presented in Example #2, you are able to reduce your mortgage rate and term by refinancing, enabling you to lower your monthly mortgage payment, reduce your total interest expense over the life of the mortgage and access the equity in your property.  Otherwise, if you can afford the higher monthly payment for a set number of years it typically makes more sense and saves you money in total interest expense over the long term to keep your current mortgage in place and obtain a home equity loan or line of credit.

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