Cash-Out Refinance vs Home Equity Loan: Which Is Best For You?

Having equity in your home opens up a lot of opportunities for meeting your financial goals. Whether you have equity because you’ve made your monthly principal payments over time or because your home has appreciated in value — or both — there are a few ways you can make the most of your equity, including a cash-out refinance or a home equity loan. Here’s what you need to know.

Cash-out refinance vs home equity loan

In both cash-out refinances and home equity loans, the amount of cash you can receive is based on the amount of equity you have in your home. And, your home serves as collateral. Both cash-out refinances and home equity loans give you a lump sum of cash, with predictable, fixed payments.

One key difference is that a cash-out refinance replaces your current mortgage with a new loan, whereas you take out a home equity loan in addition to your mortgage. And home equity loans typically have a higher interest rate.

If you’re not sure which is the right choice for you, a mortgage broker or lender can help you weigh your options.

What is a cash-out refinance?

A cash-out refinance replaces your existing mortgage with a new loan, with an updated rate and term. This loan program allows you to withdraw a sum of cash at closing. Your new mortgage payment will often be higher than your current payment because you’re also repaying the cash you took out, unless the interest rate on your new loan is significantly lower than the original. With a cash-out refinance, you can use the cash for whatever you’d like and pay it off over time as part of your monthly mortgage.

Cash type: Within a few days of closing, you’ll receive a lump sum of cash in your bank account, as a wire transfer or in the form of a check.

Cash use: Cash from a cash-out refinance can be used however you see fit.

Rates: Just like any other mortgage, your interest rate will vary based on the kind of mortgage you choose, market trends, and your credit profile. Interest rates are usually lower than a home equity loan.

Closing costs: You’ll pay 2-6% of the loan amount in closing costs. For conventional loans, closing costs are capped at 3%, though this varies state-by-state.

Payment: You’ll simply make a new monthly mortgage payment over a fixed schedule, which pays off both your home purchase and the cash you withdrew.

What is a home equity loan?

A home equity loan is often referred to as a second mortgage, as it is separate from your first mortgage. It’s simply a lump-sum loan that’s secured by the equity in your home. After you receive your cash, you’ll start repaying it with a set monthly payment, separate from your mortgage payment.

Cash type: You’ll receive a lump sum of cash at closing. Home equity loans are relatively fast, allowing you to get your money within two to six weeks from beginning your application.

Cash use: You’re allowed to use the funds however you see fit. Common uses are home improvements and college tuition.

Rates: Home equity loans have fixed rates that are typically 2-3 percentage points higher than first position loans, like a cash-out refinance. But home equity loan rates are lower than credit cards or personal loans.

Closing costs: Expect to pay between 2-5% of the home equity loan amount in closing costs.

Payment: You’ll make a fixed monthly payment until your loan is paid off. You’ll still be paying your monthly mortgage payment (if you have one), so be sure you can afford to make both payments.

Keep in mind that retaining less than 20% equity in your home increases the cost of borrowing to reduce your lender's risk. Lenders won't typically charge PMI on a home equity loan, but you can expect higher interest rates.

Qualifications for a cash-out refinance vs home equity loan

In addition to having sufficient equity in your home and steady income, here are some standard requirements for getting a cash-out refinance or a home equity loan.

How to choose between a home equity loan and a cash-out refinance

The best option for accessing your home equity depends on a few key factors, including how much you still owe on your existing mortgage, interest rates, fees and whether or not your interest will be tax deductible. Here are two potential scenarios for how you might access $50,000 in cash to help you in your decision-making process.

Scenario 1: Low principal balance

Let’s say you have a home that’s worth $300,000 with a small principal remaining — say, $25,000. You currently make payments of $1,500 per month, most of which is principal balance since your loan is amortized and your interest-heavy payments were paid earlier in your loan term.

If you choose a cash-out refinance, you’ll pay closing costs (2-6%) on a $75,000 loan ($1,500-$4,500) — your existing principal balance of $25,000 plus the $50,000 in cash you’re withdrawing. You’ll have a single monthly payment for your refinanced home loan including your cash withdrawal. But amortization on this new loan will restart.

NOTE: Talk with your financial advisor to discuss whether the $50,000 cash you plan to withdraw is worth the total amount of interest you will be required to pay on the new loan. You can work with your lender on less traditional amortization schedules such as 10-year or 27-year amortization. Talk with your financial advisor to discuss whether the $50,000 cash you plan to withdraw is worth the total amount of interest you will be required to pay on the new loan. You can work with your lender on less traditional amortization schedules such as 10-year or 27-year amortization.

If you choose a home equity loan, you’ll pay closing costs (2-5%) on your $50,000 loan amount ($1,000-$2,500) with monthly payments of principal and interest in addition to your monthly $1,500 mortgage payment.

NOTE: You will need to budget for the $1,500 monthly mortgage payment in addition to the new home equity loan payment of approximately $418, assuming an 8% interest rate on a 20-year home equity loan term. Even if you qualify, make sure that your new total monthly payments ($1,918) make sense for your spending habits, and your need for $50,000 now is worth $50,372 in total interest payments.

Scenario 2: High principal balance

Let’s use the same example of a home that’s worth $300,000, but instead of a small remaining principal, you still have a significant principal remaining — say, $200,000.

If you choose a cash-out refinance, you’ll pay closing costs (2-6%) on a $250,000 loan ($5,000-$15,000) which consists of your existing principal balance of $200,000 plus the $50,000 you’re withdrawing. In this case, you’re likely still paying a significant amount of interest due to your amortization schedule (approximately $130,000), so your new interest payments (plus approximately $33,000) are likely going to be similar to the amount you were paying on your mortgage if you’ve acquired a competitive interest rate.

NOTE: In this scenario, the cash-out refinance method likely results in steep closing costs. Consult with your financial adviser about alternative methods of accessing a $50,000 cash loan with lower fees.

If you choose a home equity loan, you’ll pay closing costs (2-5%) on your $50,000 loan amount ($1,000-$2,500), and monthly payments with interest. Additionally, you’ll continue to make your monthly $1,500 mortgage payment. Your interest payments can cost as much as the loan itself; in this scenario, the loan is $50,000 and the interest costs $50,372.

NOTE: Make sure you can afford the $1,500 monthly mortgage payment plus the new home equity loan payment of approximately $418, assuming an 8% interest rate on a 20-year home equity loan term. And remain diligent about paying both lenders on time.

Reasons to choose a cash-out refinance instead of a home equity loan

Sometimes, it makes more sense for homeowners to do a cash-out refinance instead of getting a home equity loan. Here are some of the most common reasons.

When your home is paid off

If you own your home outright and want to access equity without selling, a cash-out refi can be an affordable way to get the cash you want. Your refinance will have a lower interest rate, making it a cheaper option to access your home equity.

When you need to borrow a large amount of money

If you need a large sum of money, it usually makes sense to get a cash-out refinance, since you can repay it a little at a time over the life of your mortgage–instead of adding a second, expensive monthly payment. Keep in mind, if your current mortgage rate is considerably lower than today’s refinance rates, a refinance may not be the obvious choice. Work with a lender and confirm the cost of interest over the life of your new loan.

When rates are low

If current interest rates are lower than your current mortgage interest rate, a cash-out refinance can be a win-win: You lock in a lower interest rate while also accessing a portion of your equity in cash. If you’ve owned your home for more than half of your mortgage term, work with a lender to ensure it’s cost effective to refinance an amortized mortgage at a lower interest rate — you may already be making mostly principal payments.

When your goal is debt consolidation

A cash-out refinance can be a helpful tool in consolidating debt, as your interest rate may be lower, and you’ll only have one payment to make instead of multiple monthly bills.

Reasons to choose a home equity loan instead of a cash-out refinance

A home equity loan is often a faster and easier way to access cash, as you won’t have to go through a full refinance process. Here are a few circumstances where a home equity loan might make more sense.

When you do not want to alter the terms of your existing mortgage

If your existing mortgage has a great rate and current interest rates are higher, it’s probably not worth doing a refinance. Also, if you are already pretty far into paying off your mortgage, it may not make sense to refinance, since you’re already paying mostly principal.

When you may not qualify for a cash-out refinance

Generally, home equity loans are easier to qualify for than refinances or HELOCs. However, it’s important to make sure you can cover both your monthly mortgage payment and the monthly loan payment. If you’re facing financial trouble, the practice of moving debt from one place to another can be risky, especially since your home is collateral.

When you need cash ASAP

A home equity loan can close sooner than a cash-out refinance, putting cash in hand in just two to six weeks, compared to a standard closing timeline of 30-45 days.

When you want to buy a house but need to access your current home’s equity

If you’re buying a new home before selling your current home, you may want to free up some of your equity to use in your new down payment — perhaps in order to avoid having to pay PMI. A home equity loan can help you access that money before selling, and then you can pay off the loan at closing.

What’s the difference between a home equity loan and a HELOC?

While both a home equity loan and a home equity line of credit (HELOC) give you access to the equity in your home, they have a few key differences. Most importantly, a home equity loan is a lump sum of cash with a set monthly repayment amount, whereas a HELOC is a revolving line of credit with a variable interest rate.

Refinance vs home equity loan FAQs

Which is more expensive, a cash-out refinance or home equity loan?

Closing costs for a cash-out refinance can be higher than a home equity loan, especially for FHA and VA borrowers. But, interest rates are often lower on a cash-out refinance. So, depending on the amount you plan to borrow, higher interest rates could make a home equity loan the more expensive choice.

Do you lose equity in your home with a home equity loan?

A home equity loan simply redistributes a portion of your home’s equity into cash. But, once you start spending that money, you are losing equity. When you’ve repaid your home equity loan, you’ll recover your full equity. Also, if you use your home equity loan to invest in home improvements, it may gain you additional equity.

What are the differences between a refinance and a home equity loan?

Refinancing involves paying off your old mortgage balance with a new loan, often with an improved rate or terms. The most common type is a rate-and-term refinance, but it doesn’t allow you to withdraw any of your home equity. To withdraw equity as cash, you’d need to do a cash-out refinance. A cash-out refinance is different from a home equity loan because it involves replacing your current mortgage with a new, higher loan. Conversely, a home equity loan is a separate loan from your existing mortgage.