Home equity loans and mortgage refinancing offer different ways to borrow money using your home as collateral. Despite that similarity, they are very different loan products. An equity loan is a second mortgage, with the financing based on equity you have built up in the home. A refinance simply means you acquire a new loan to payoff your previous one. Understanding the qualities of each helps you decide whether one or both makes sense.
A home equity loan is an option for a homeowner looking to free up money to use. Thus, if you have education expenses, want to start a business or are looking to renovate your home, borrowing against the home's equity is an option. With a home equity loan, you get a lump sum payout upfront and repay the loan on an amortization schedule over time. Essentially, you buy now and pay later on whatever you use the money for.
The merit of an equity loan versus a personal loan is based on your approach to risk. Home-secured financing typically offers a much lower interest rate than unsecured loans. Plus, equity financing is often tax deductible, which reduces your tax obligation. You have to weigh these financial advantages against the reality of pinning your property to a second mortgage. If you can't repay either your first or second mortgages, you risk losing your property to foreclosure.
A mortgage refinance has a significantly different primary purpose. It is a move usually used to get into a better position on a long-term interest rate. If your original mortgage was at 6.5 percent, for instance, a refinance to a 3.5 percent loan could result in significantly lower monthly payments. When you extend your payoff term with a refinance, you can also significantly reduce payments, which enables homeowners to payoff credit card debt or other personal debt. In essence, a refinance is intended to put you into a better financial position as you pay off your home.
Similar to equity financing, when you refinance, the interest on your new loan is tax deductible. You actually reduce your interest obligation, though, when your rate is lower. A refinance is not a new loan, it is simply a replacement for an existing mortgage. However, if you have equity in the home when you refinance, you could decide to get the new mortgage for the full value of your home and cash out the equity. The most pressing drawback is that you normally pay upfront closing costs to get the loan. This is akin to an investment, and the return is what you save over time on the new mortgage.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.