What’s the difference between a home equity loan and a cash-out refi?
The biggest difference here is that a cash-out refinance is a primary or “first” mortgage while a home equity loan is a ”second mortgage.”
As a first mortgage, a cash-out refinance replaces your existing home loan while taking cash from your equity. A home equity loan, because it’s a second mortgage, borrows only from your home equity and leaves your current mortgage in place.
Homeowners tend to prefer cash-out refinancing when mortgage rates are down and they can pay off their home loan at a lower rate. But when mortgage rates are high, a home equity loan often makes more sense.
In this article (Skip to…)
- Cash-out refinance
- Home equity loan
- Comparison table
- Pros and cons
- Interest rates
- Which loan is best?
How does a cash-out refinance work?
When you use a cash-out refinance to withdraw home equity, it replaces your existing mortgage with a new, larger loan. The new loan pays off your current mortgage and any “extra” money (the difference between your old loan amount and your new one) is returned to you as cash back at closing.
A cash-out refinance essentially rolls your mortgage and your equity borrowing into a single loan, so you still have just one mortgage and one monthly loan payment.
How does a home equity loan work?
When you use a home equity loan, you take out a second mortgage on top of your current home loan. The amount you can borrow is based on your available equity and the full loan amount will be cashed out to you at closing. The new loan is totally separate from your existing mortgage, so in the end you’ll have two different home loans and two monthly payments.
Cash-out refinance vs. home equity loan comparison
Here’s a brief overview comparing the main features of a cash-out refinance vs. a home equity loan:
|Cash-Out Refi||Home Equity Loan|
|Loan Type||First mortgage||Second mortgage|
|One-Time Cash Payment||✔||✔|
|Fixed Interest Rates||✔||✔|
|Replaces Existing Loan||✔|
|Creates A Second Loan||✔|
|Max. Loan Amount*||80%||80-85%|
|Best For||Refinance to a lower rate while taking cash out||Cash out equity without refinancing|
*Loan amount expressed as a percentage of home’s appraised value. Max. home equity loan amount includes the first and second mortgage combined. Home equity loan limits vary by lender.
Cash-out refinance vs. home equity loan pros and cons
Compared to a home equity loan, a cash-out refi is simpler because it combines your primary mortgage and your cash back into a single loan. You’re left with just one loan and one monthly mortgage payment.
However, the downside to a cash-out refi is that you have to refinance your existing mortgage. That means closing costs will be higher and, if rates have risen since you got your original home loan, you could end up with a higher mortgage rate on your entire loan balance. That would likely mean paying a lot more total interest in the long run.
A home equity loan is a little more complex than a cash-out refinance because you end up with two separate home loans and two monthly mortgage payments.
However, the upside is that a home equity loan won’t impact your existing mortgage at all. So if you already have a low interest rate, you can keep that affordable mortgage in place and pay today’s higher rates only on what you borrow from your equity.
Home equity loan rates vs. refinance rates
Home equity loans and cash-out loans both have fixed interest rates and stable monthly mortgage payments. However, home equity loan rates are usually higher than cash-out refi rates. That’s because second mortgages are considered riskier for lenders.
Keep in mind that if you use a home equity loan, the amount you borrow will be smaller than if you’d done a cash-out refinance. So even though your interest rate is higher, you’re paying that rate only on the amount of equity you borrow.
By contrast, when you take a cash-out refi, the new interest rate is charged on both your cash-back and your previous loan balance (remember, the old loan balance is rolled into your new cash-out loan). So if today’s interest rates are higher than your previous rate, you’d be paying more interest not only on your equity but on your entire mortgage loan as well.
Most homeowners prefer a cash-out refinance when rates are low, allowing them to both cash out equity and drop the rate on their primary home loan. When rates are high, however, homeowners usually prefer a home equity loan or home equity line of credit (HELOC) to avoid increasing the rate on their existing loan balance.
HELOC vs. cash-out refinance or home equity loan
When you want to cash out real estate, home equity loans and cash-out refinancing aren’t your only options. You could also look at a home equity line of credit (HELOC).
HELOCs work differently from either home equity loans or cash-out refinancing. Both those options come with a one-time cash payment at closing, which you start paying off immediately. In this way, cash-out loans and home equity loans are like traditional mortgages.
A HELOC, on the other hand, is structured as a line of credit. At closing, instead of receiving a lump sum of cash, you’ll receive access to a card or account with a maximum credit limit. You can borrow from this, pay it back, and borrow again throughout your HELOC’s “draw period” (which often lasts up to ten years).
Using a HELOC is a lot like using a credit card; you can spend up to your limit and you pay interest only on what you borrow. But, at the end of the HELOC draw period, you’ll enter a repayment period during which you have to pay back any remaining loan balance plus interest — and you can no longer borrow from the credit line.
It’s also important to note that HELOC interest rates are typically variable whereas cash-out refi and home equity loan rates are fixed. When you have a HELOC, you might pay less because you only pay interest on what you charge to the credit line. But if the Fed raises interest rates, your borrowing costs could go up.
What’s the best way to cash out home equity?
How do you decide between a cash-out refinance, home equity loan, or HELOC? The choice largely depends on two things: what you need the money for and the status of your existing home loan.
If you can get a lower interest rate on your current loan — and you’re not close to paying it off — a cash-out refinance is usually the best bet. When you can cash out equity and drop your mortgage rate at the same time, it’s a win-win.
If refinancing would lead to a higher rate, or if it would extend your payoff date and cause you to pay more in the long run, then a cash-out refi likely won’t make sense. In that case, consider a home equity loan or HELOC instead.
- A home equity loan might be best if you know exactly how much cash you need up front (for instance, for a fixed-cost renovation project)
- A HELOC might be better if you need an ongoing source of funding or want access to extra cash in case of emergencies
Each loan type will come with its own set of closing costs and requirements. There’s a lot to consider here, so work closely with your loan officer to figure out which cash-back loan is right for your needs.
Cash-out refinance vs. home equity loan FAQ
A home equity loan works a lot like a cash-out refinance, but they’re not the same. Cash-out refinancing will replace your existing mortgage with a new loan that offers cash-back at closing. A home equity loan, on the other hand, doesn’t affect your current mortgage. It’s a totally separate loan that’s used only to tap your home’s cash value.
When mortgage interest rates are up, a home equity loan is usually cheaper than refinancing. That’s because it won’t increase the interest rate or monthly payments on your current home loan. In addition, a cash-out refinance typically has higher closing costs than a home equity loan because you’re borrowing more money in total.
The primary disadvantage of a cash-out refinance is that, if current mortgage rates have risen, you might increase your rate and monthly mortgage payment by refinancing. That means you’ll pay more interest over the life of the loan. Cash-out refi closing costs can also be high: around 2%-5% of the total loan amount. Finally, if your home is almost paid off, refinancing would increase the time to pay off your loan — which leads to more interest paid in total.
Cashing out home equity can be a good idea when you need to borrow a lot of money. Since cash-out refis and home equity loans are secured by your house, they have far lower interest rates than credit cards or personal loans. That means they’re a cheap way to finance big-ticket items like home improvements or buying an investment property. However, experts usually don’t recommend cashing out equity for purchases with no return on investment, like a new car or paying for an expensive vacation.
If a refinance would increase your mortgage rate, it’s probably better to use a HELOC. A HELOC lets you take cash from your equity without replacing your existing home loan. Plus, you don’t have to use the HELOC after opening it. If you don’t borrow from the credit line, you won’t have any principal or interest to repay.
Your next steps
Cash-out refinancing, home equity loans, and HELOCs are all good options for tapping your home’s cash value.
With mortgage rates on the rise since the Covid pandemic, many homeowners are choosing a home equity loan or HELOC over a cash-out refi. But what’s true for most people might not be true for you. The right choice will depend on your credit score, your current home loan, and your home’s value, among other factors.
If you’re ready to cash out home equity, get in touch with a loan officer to talk about options. Your lender will help you compare loan types, upfront fees, and interest rates to find the best mortgage for you.