Choosing the right loan can save you anywhere from hundreds to thousands of dollars in costs. So it pays to consider your options before you decide what type of loan you really need.
A personal loan might come with an origination fee and a relatively high interest rate, but a cash-out refinancing loan will entail considerable closing costs. Timing is another concern. If you need funds quickly, a cash-out refinancing loan is probably not an option because approval can take weeks, whereas a personal loan can deliver funds within days.
Here’s a look at the factors to consider when deciding between a personal loan vs. a cash-out refinance. We’ll examine what both types of loans are, discuss why one might be preferable over the other, and offer a side-by-side comparison of the two types of loans so you can make an educated decision.
Table of Contents
Key Points
• A personal loan is an unsecured loan with a relatively higher interest rate, while a cash-out refinance is a secured loan with lower interest rates.
• Personal loans offer fast approval and funding, often within days, whereas cash-out refinancing typically takes weeks due to the mortgage application process.
• Cash-out refinancing allows borrowing larger amounts based on home equity, usually up to 80% of the home’s value.
• Cash-out refinancing involves significant closing costs, ranging from 2%-5% of the loan amount, while personal loans generally have an origination fee.
• Both personal loans and cash-out refinancing loans can be used for any purpose.
What Does a Personal Loan Include?
A personal loan is typically an unsecured loan offered by a bank, credit union, or online lender. An unsecured loan is usually not backed by collateral, which means the lender will charge a higher interest rate to cover the cost of their risk. When a personal loan is approved, the borrower receives cash in their bank account, often within one business day, and pays a monthly payment that includes some of the principal and the interest due. The funds from a personal loan can be used for any purpose.
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What Is a Cash-Out Mortgage Refinance?
A cash-out mortgage refinance is a type of secured loan that a borrower obtains by using their home as collateral as they pay off their old mortgage and get a new one. If you default on the payments, the bank or lender can repossess or foreclose on your home. There is less risk for the lender when the loan is backed by collateral, so the interest rates are lower.
With a cash-out mortgage refinance, the overall loan amount has to be large enough to pay off your existing mortgage and provide you with a certain amount of cash. So, it’s likely to be a large loan.
To determine whether or not you qualify for a cash-out mortgage refinance, a lender will look at your income, employment, debt, property value, and credit history. These factors will also help decide your loan terms, should you qualify. As with a personal loan or a home mortgage loan, you will pay it back in monthly payments that include some of the principal and some of the interest due. There are no restrictions on how you use the money with this loan either.
đź’ˇ Quick Tip: There are two basic types of mortgage refinancing: cash-out and rate-and-term. A cash-out refinance loan means getting a larger loan than what you currently owe, while a rate-and-term refinance replaces your existing mortgage with a new one with different terms.
Cash-Out Refinance vs Personal Loan: A Comparison
If you’re contemplating the repercussions of taking out a mortgage refinance loan compared to a personal loan, critical factors to consider are collateral, interest rates, how quickly you will have access to funds, and closing costs. Below is a side-by-side comparison of the main factors likely to influence your decision.
|
Personal Loan vs. Cash-Out Refinancing Loan |
||
|---|---|---|
| Personal Loan | Cash-Out Mortgage Refinance | |
| No collateral | ✓ | |
| Unlimited use of funds | ✓ | ✓ |
| Lower interest rate | ✓ | |
| Longer repayment period | ✓ | |
| Higher borrowing limit | ✓ | |
| Fast approval and funding | ✓ | |
| No or low closing costs | ✓ | |
| Lower fees | ✓ | |
| Possible tax benefits | ✓ | |
Home Equity and Collateral
Deciding whether to take out an unsecured personal loan or a secured cash-out refinancing comes down to how much equity you have in your home, how quickly you need the funds, and which type of loan will be cheaper. Making the right decision requires understanding the interest rates and terms you would qualify for with each type of loan. Also know that you risk losing your home if you choose cash-out refinancing but fail to make the payments.
To refinance your home and let you take cash out with a loan, a lender will require you to keep 20% equity, which limits your new loan amount to 80% of your home’s appraised value. A personal loan has no limits on the amount you can borrow, except for those dictated by the bank.
Cost and Interest Rates
The cost of a loan, whether a personal or home loan, is largely determined by interest rate. The interest rate you receive on a mortgage loan vs. a personal loan will depend on whether you meet or exceed the minimum credit score for a personal loan, as well as on your income and the loan amount.
Personal loans, because they are unsecured, have higher interest rates than home loans. Credit card financing could be an option, but credit cards are typically even more expensive. People often use a personal loan or a cash-out refinance to consolidate debt and pay off credit cards.
Speed of Approval and Funding
How soon you receive funding varies significantly between the two types of loans. The application for a personal loan is often completed online, and if you are approved, you could receive funding within days, sometimes as fast as one business day. The home mortgage loan application process, including refinances, requires significant documentation, such as underwriting, an appraisal, and legal documents, and can take weeks.
Loan Amount
The loan amount for a personal loan varies. Some banks will offer loans as low as $600 or as high as $100,000. Most lenders set a minimum around $5,000 and a maximum around $50,000. Cash-out refinancing home loans, however, tend to be much larger, and they depend on your equity and the value of your home. As noted above, you can typically take out a new loan for up to 80% of the value of your home, though you will need to pay off your old mortgage balance with it, too.
Closing Costs and Loan Fees
Many personal loans have a relatively small origination fee and no closing costs. The fees for any loan will depend on the lender. But you can bet on a fee in the range of 1% to 10% for a personal loan.
Mortgage loans tend to be much larger, and closing costs and fees can range from 2% to 5% for a cash-out refinancing loan. The originator of the home loan charges fees to cover origination, document processing, and underwriting.
As an example, if you needed to borrow $10,000, you might pay around $500 in fees for a personal loan. If you chose cash-out refinancing, you’d have to borrow $10,000 plus the amount of your mortgage balance. If your mortgage balance is $150,000, you’d pay closing costs on $160,000, which could be as much as $8,000.
Length of Repayment Period
Repayment terms for a home refinancing loan will be longer than the terms for a personal loan because the loan amount will be higher. The repayment period for a personal loan is typically from one to seven years. Home loan terms typically range from 15 to 30 years. A few lenders will offer a 10-year term.
Eligibility for Tax Benefits
You might be eligible for tax benefits for a cash-out refinancing loan. It’s worth noting that a borrower doesn’t need to report cash received from a cash-out refinancing loan as income, because it is considered a form of debt. If you itemize your taxes, you will likely be able to deduct some or all of the mortgage interest from your new mortgage, and you might also be able to deduct interest you paid on the rest of the loan if you used the cash to buy, build, or make major improvements to your home, but you will need to keep receipts and records to show the work that you did. A tax professional can help you determine if you qualify for this benefit.
There are also limited circumstances in which the interest for a personal loan may be tax-deductible – when you use the loan to fund a business, for instance. Again, it’s a good idea to talk to a tax professional to discuss the specifics in your case.
💡 Quick Tip: Generally, the lower your debt-to-income ratio, the better loan terms you’ll be offered. One way to improve your ratio is to increase your income (hello, side hustle!). Another way is to consolidate your debt and lower your monthly debt payments.
The Takeaway
If you need funds and are trying to decide between a personal loan or a cash-out refinancing loan, the main factors to consider are how much money you need, how soon you need it, and how much you can afford to spend each month to pay off the loan.
Personal loans are typically the better option if you want to borrow a few thousand or less and you need the funds quickly. On the other hand, a cash-out refinancing loan may be better if you want to borrow a larger amount and spread the payments over a longer period. With both options, your credit score will drop if you miss payments, and with a cash-out refinancing loan, you also risk your home falling into foreclosure if you cannot meet your monthly payment obligations.
Turn your home equity into cash with a cash-out refi. Pay down high-interest debt, or increase your home’s value with a remodel. Get your rate in a matter of minutes, without affecting your credit score.*
FAQ
Can I use a personal loan or a cash-out refinance to pay off my mortgage early?
You can use personal loans and cash from a refinancing to pay for anything you like. People often use both types of loans to pay off credit card debt or student loans, because the interest rates and total cost of the loan might be a cheaper option.
How do I determine if the terms of a personal loan or a cash-out refinance are right for me?
To decide whether to use a personal loan or to refinance, consider your priorities. For example, a mortgage refinancing would be better if you want lower monthly payments spread out over a longer period. If you only want to borrow a few thousand dollars, a personal loan would be better because there are no closing costs. Also, consider whether you want to use your home as collateral.
Can I get a personal loan or a cash-out refinance if I am self-employed?
Yes, as long as you can document a regular and reliable source of income and meet other qualifications set out by the lender, being self-employed shouldn’t affect your ability to qualify for a personal loan or a cash-out mortgage refinancing loan.
What are the consequences of missing a payment on a personal loan or a cash-out refinance?
Missing payments on a personal loan will cause you to incur late fees and may reduce your credit score significantly. The same is true if you miss payments on a refinance loan. However, in this case you could also be at risk of foreclosure if you miss payments repeatedly.
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