- Both home equity loans and cash-out refinances allow you to turn home equity into cash.
- A cash-out refinancing replaces your existing mortgage with one that has a larger balance.
- A home equity loan is considered a second mortgage and comes with an additional monthly payment.
When you own a home, over time you'll build up equity as you make payments on your mortgage and the value of your home grows.
Equity is the value of your home that you own outright — you can figure out what yours is by subtracting your mortgage balance from your home's total value.
Some types of mortgages let you tap into that equity and turn it into cash. Homeowners can then use their equity to pay for things like home repairs, renovations, or unexpected expenses.
Cash-out refinancing and home equity loans are two of the most popular tools available to access your equity. But they aren't created equal. Here's what you need to know about each to help decide which is best.
Cash-out refinance vs. home equity loan: What's the difference?
What is a cash-out refinance?
A cash-out refinance works like this: You apply for a new mortgage loan that's larger than your current one. Once approved, that loan is used to pay off your old one, and you get the difference back in cash at closing.
Here's an example of a cash-out refinance: Say your home is worth $500,000, and your current mortgage loan balance is $300,000. The cash-out refinancing process would look something like this:
- You'd apply for a new mortgage loan. Cash-out refinances typically allow for up to an 80% loan-to-value ratio, which means you could apply for as much as $400,000 in funding ($500,000 x .80).
- You'd submit the required financial documentation. Lenders typically require bank statements, pay stubs, tax returns, and W-2s, among other items.
- Have your home appraised. In most cases, your lender will want to verify your home's value with a new appraisal.
- You'd close on the loan, and the new loan would be used to pay off the old mortgage balance, leaving you with an overage of $100,000.
- You'd get that $100,000 in a lump-sum payment within a few days of closing.
Important: The above numbers are just examples. The exact amount of money you can access will depend on your home's value, how much equity you have in the property, and your credit score.
What is a home equity loan?
A home equity loan is a type of second mortgage. Unlike cash-out refinancing, it doesn't replace your current mortgage loan. Instead, it's a loan in addition to your original mortgage — meaning you'll have two monthly mortgage payments.
Say your home's value is $500,000. If your home equity loan lender allows for loan-to-value ratios up to 80%, you could access as much as $400,000 across both your main mortgage and a new home equity loan. If your current mortgage balance was $350,000, for example, a home equity loan could presumably offer you up to $50,000 in upfront cash ($400,000 - $350,000).
To get your home equity loan, you'd file an application with your chosen lender, submit documentation, and have your house appraised. Once you pay your closing costs and sign the paperwork, you'd receive your lump-sum payment a few days later. You'd then begin making monthly payments toward your home equity loan starting the next month.
Comparing a cash-out refinance to home equity loans
Cash-out refinancing and home equity loans both allow you to access your home equity with a single lump-sum payment, but there are some key differences between these loan types.
| Cash-out refinance | Home equity loan | |
| Interest rates | Lower rates | Higher rates |
| Rate type | Fixed or ARM | Fixed |
| Term length | 15-year and 30-year options | Between five and 30 years |
| Max LTV | 80% | 80% to 90% |
Interest rates and loan terms
With a cash-out refinance, you have the option to get a fixed-rate or an adjustable-rate mortgage. Home equity loans are typically only available with fixed rates.
Home equity loan rates also tend to be slightly higher than the regular mortgage rates you'd get with a cash-out refinance. This is because they're second-lien mortgages, meaning they're subordinate to your first mortgage. If you were to default on your loan, the lender on your first mortgage would get the proceeds from foreclosing on your house first. Your home equity lender would only get what's left over — which may not be enough to settle your debt.
For this reason, home equity loans are riskier for lenders. They offset this risk with higher interest rates.
As for terms, cash-out refinances often come in 15- and 30-year terms, while home equity loans are five to 30 years.
Payment structure and loan amount
Payments are also different with these two loan options. While both are due monthly, a cash-out refinance replaces your current mortgage loan entirely, so you'll only have one payment after closing. A home equity loan is a new loan on top of your existing mortgage, so it will come with an additional monthly payment.
Both loans limit how much you can borrow based on your home's value. On cash-out refinances, you can usually borrow up to 80% of your home's value. With home equity loans, it's 80% to 90%, minus the balance on your current mortgage.
Advantages of cash-out refinances
Potentially lower interest rates
Because a cash-out refinance replaces your existing mortgage, it offers the lowest rates compared to other equity-tapping options.
"It's the cheapest way to borrow against the equity in your home," says Melissa Cohn, regional vice president of William Raveis Mortgage.
You'll also benefit if current rates are lower than what you're paying on your mortgage. However, if you have a low rate and the rates available now are higher, replacing your current mortgage might not be a good idea. This is why it's critical to weigh the current market before opting to refinance.
Consolidation of home loan into a single payment
With a home equity loan, you'll have to manage two monthly payments. A cash-out refinance helps you access your equity while still keeping one single payment for your home. This can make it easier to budget and plan for.
Since you can also use the funds from cash-out refinances to pay off credit cards and other debts, this consolidates those into one single monthly payment as well.
May be easier to qualify for
The credit score requirements to get a mortgage are typically a little lower than the requirements to get a home equity loan. Many home equity loan lenders require scores of at least 680, while you'll need a score of 620 or higher to qualify for a cash-out refinance.
Advantages of home equity loans
Fixed interest rates and predictable monthly payments
Home equity loan interest rates are fixed, so they allow you to tap your home equity in a manageable, predictable way. For your entire loan term, you can be confident your rate — as well as your monthly payment — will never change, and you'll always know what you owe and when.
This is nice compared to other second mortgages — namely, the home equity line of credit (HELOC). These have variable rates, so your payment can change often over the course of your loan term.
No need to refinance your primary mortgage
Home equity loans let you keep the terms of your original mortgage, which might be good if you're very far into your amortization schedule when more of your payments are going toward your principal balance and not toward interest. It's also smart if interest rates on traditional mortgages are rising, and you don't want to lose the low rate you already have.
"For homeowners whose primary mortgage rate is below the current market rates, a home equity loan is more likely to be the better choice," says Nicole Straub, SVP and head of Discover Home Loans. "By choosing this option, it allows them to keep the low rate they have while also allowing them to tap into the equity they have in their home."
Lower closing costs
Home equity loans typically have lower closing costs compared to cash-out refinances. In fact, some lenders don't charge closing costs on their home equity loans (though you'll still pay some third-party fees).
How to decide between a cash-out refinance and home equity loan
Impact on your mortgage and overall debt
Run the numbers with both options and see what they would add to the long-term interest costs of your mortgage. Also, would it mean a longer payoff period? This could slow your savings and investing efforts for other goals, like retirement, for example.
You should also think about the impact on your monthly payment and make sure your household budget can handle any potential increase — not just now, but for the life of the loan, too.
Closing costs and fees
Both cash-out refinances and home equity loans come with closing costs and upfront fees. Home equity loans typically have lower closing costs (but remember, they add a second payment to your monthly obligations, too). In either case, make sure you have the savings on hand to cover these costs without eating into your emergency fund.
Sometimes, lenders will let you finance closing costs and add them to your loan amount. Be careful with this tactic, as it can increase your payment and long-term interest costs quite a bit.
Assessing your financial goals and current situation
What are your goals for the loan? If you're simply looking to cover home repairs — and not replace the terms or rate on your current mortgage — then a home equity loan may be the better option. But if you have a high-rate first mortgage and need access to cash, refinancing could be a smarter move.
Your plans for the future factor in, too. Refinancing and home equity loans both come with fees, so you'll want to be sure you're in the home long enough to make those worth it.
Check mortgage rates
Cash-out refinance vs. home equity loan FAQs
Is a home equity loan better than a cash-out refinance?
A home equity loan may be better if you want to keep your current mortgage the same, including the rate.
Can I use a cash-out refinance or home equity loan for any purpose?
Yes, both cash-out refinancing and home equity loans allow you to use the funds for any purpose. Many homeowners use them for home improvements, debt consolidation, or major purchases.
How do closing costs compare between cash-out refinances and home equity loans?
Closing costs for cash-out refinancing are generally a percentage of the loan amount and can be higher than those for home equity loans, which tend to have lower closing costs.
What are the disadvantages of a cash-out refinance?
Cash-out refinances come with higher costs and force you to replace your current mortgage, which might not be a good idea if you have a good rate.
Is it faster to get a home equity loan?
The process for obtaining a home equity loan can be quicker and involve less paperwork than a cash-out refinance, which is more similar to applying for a new mortgage.
