I need $55,000 for home improvement. My home’s estimated market value is $230,000. Currently, my mortgage balance is $65,000 at 6.00%. The remaining term is 130 months. Should I refinance my existing mortgage, or take out a $55,000 home equity loan?

Generally speaking, if your existing mortgage interest rate is lower than the current market rates, you’ll be better off with a second mortgage such as a home equity loan than a cash-out refinance.

However, to be sure, you must work out some numbers and compare the cash flows of the cash-out refinance option and the home equity loan option. Such analyses are simple to carry out. Let me illustrate with some examples.

(1) The current information of your home and loan

(2) I’ve received some free quotes from a lender (let’s call this lender ‘lender x‘).

Here’s the best quote for a 15-year $55,000 home equity loan from lender x:

Assuming you’ll have the lender fees and other costs financed, you’ll borrow $55,000 + $749 + $487 = $56,236 at 8.950% fixed for 15 years.

Your monthly payment = $568.71 (you can easily get this figure from a mortgage calculator).

Therefore total payment for the home equity loan for 180 months (ie 15 years) = $568.71 x 180 = $102,368

Therefore if you take out a home equity loan, your monthly loan payment = existing mortgage monthly payment ($681.19) + new home equity loan monthly payment ($568.71).
Your total loan payment for the 15-year period = total mortgae payment ($88,554) + total home equity loan payment ($102,368) = $190,922.

(3) Here’s the best quote from lender x for a 15-year fixed-rate cash-out refinance mortgage:

Assuming you’ll have the lender fees and other closing costs financed by the lender, your refinance amount will be $126,844 so that after paying off the existing mortgage of $65,000, the lender fees of $5,055 and the other closing costs of $1,789, you’ll be left with $55,000 cash for your home improvement, ie $126,844 - $65,000 - $5,055 - $1,789 = $55,000.

Using a mortgage calculator, you’ll find out that your monthly payment = $1,003.07.

The total payment over the 15-year period for your refinance mortgage = $1,003.07 x 180 = $180,553.

Compare the two total payments:

It’s clear that taking a new cash-out refinance mortgage will ‘cost’ you less cash.

(4) Taking out a new cash-out refinance mortgage is not always cheaper. If you refinance at a higher rate, say 6.25%, you may be worse off compared with taking out the new home equity loan at 8.95% stated in paragraph (2) above, depending on the lender fees, points and other closing costs, and your income tax rate.

What you have to bear in mind is that by merely comparing interest rates you cannot be sure of making the right decision. You must work out and compare the cash flows of your various options.

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