Cash-Out Refinance Vs. Home Equity Loan
Life has a way of throwing big expenses your way—whether it’s a long-overdue home improvement, mounting medical bills, or a chance to finally knock out high-interest debt.
If you’re a homeowner, you might already have a powerful tool to cover those costs: your home’s equity. Instead of turning to credit cards or personal loans with higher interest rates, you can tap into the value of your property with either a cash-out refinance or a home equity loan.
But which one makes the most sense for you? Let’s break down the key differences so you can make the right choice. And when you’re ready, you can start your cash-out refinance or explore a home equity line of credit (HELOC) through Rate to find the best fit.
What Is a Cash-Out Refinance?
A cash-out refinance lets you replace your current mortgage with a new mortgage loan that’s larger than what you currently owe.
The extra amount you borrow, your home equity, is given to you as a lump sum of cash that you can use for home improvement, debt consolidation, or other major expenses like medical bills or college tuition.
For example, say your home’s value is $300,000, and you still owe $150,000 on your mortgage balance. If you qualify for a cash-out refi of $200,000, you’d get $50,000 in cash, while the rest goes toward paying off your original mortgage aside from closing costs and fees.
This can be a great option if you want to tap into your home’s equity while locking in a lower interest rate.
But there’s a catch, your monthly payment might increase, and if your property value drops, you could end up with less equity than expected. That’s why it’s important to run the numbers and make sure this is the right choice for your financial situation.
Pros and Cons of a Cash-Out Refinance
A cash-out refinance can give you access to extra funds, but it also comes with risks. Here’s what to consider:
Pros
- A cash-out refinance usually offers a lower rate than a home equity loan or a home equity line of credit (HELOC).
- Instead of managing a second mortgage, you’ll only have one mortgage payment to make.
- If you use the funds for home improvements, you may be able to deduct some of the interest when filing taxes.
- You may qualify for a larger loan amount compared to a home equity loan, giving you access to more cash for major expenses like debt consolidation or college tuition.
Cons
- Since you’re borrowing more than your current mortgage, your monthly payment could increase.
- A cash-out refinancing comes with fees similar to your first mortgage, such as appraisal and origination costs.
- If home values drop, you could owe more than your property is worth, making it harder to sell or refinance.
How Often Can You Do a Cash-Out Refinance?
There’s no set rule on how many times you can do a cash-out refinance, but most lenders require a waiting period, usually six months, before you can refinance again. This is known as a seasoning period and helps ensure you’ve built up enough equity before borrowing more.
Your ability to cash-out refinance multiple times depends on factors like your credit score, loan-to-value (LTV) ratio, and market conditions.
If interest rates are lower than when you last refinanced, it might make sense to do it again. But if rates have climbed or your home’s value hasn’t increased much, holding off could be the better option.
How Does a Cash-Out Refinance Affect Taxes?
Using a cash-out refi to renovate your house might come with a tax benefit—but using it for other things, like paying off a credit card, won’t.* The Federal Reserve allows you to deduct mortgage interest if the funds are used for home improvement projects that increase your home’s value.
However, if you spend the cash on debt consolidation, college tuition, or anything else unrelated to your property, you won’t qualify for a mortgage interest deduction.
To understand the potential impact on your taxes, it’s best to check with a financial advisor before making any big moves.
What Is a Home Equity Loan?
A home equity loan is a type of second mortgage that lets you borrow a lump sum of cash against your home’s equity without changing your current mortgage loan.
It’s a good option if you need funds but don’t want to touch your first mortgage, especially if you already have a low mortgage rate.
Unlike a HELOC which works more like a credit card, a home equity loan comes with a fixed interest rate. That means your monthly payments stay the same throughout the repayment term, making it easier to budget.
This loan option is often used for home improvement projects, major expenses, or debt consolidation, but keep in mind—it’s a second loan, so you’ll have two payments to make each month.
Pros and Cons of a Home Equity Loan
A home equity loan gives you a lump sum with fixed payments, but it also adds a second loan to manage. Here’s what to consider:
Pros
- Unlike a HELOC, a traditional home equity loan offers predictable repayment terms.
- You receive all the money at once, making it easier to budget for home improvement projects or medical bills.
- Your primary mortgage stays the same, and you get a separate loan.
- You may be able to qualify even if your credit score isn’t high enough for a cash-out refinance, since lenders focus more on home equity and loan-to-value (LTV) ratio rather than just credit history.
Cons
- You’ll have two monthly payments—your original mortgage and your home equity loan.
- Compared to a cash-out refinance, a home equity loan interest rate is typically higher.
- Just like a mortgage loan, failure to repay could lead to foreclosure.
Can You Refinance Your Home Equity Loan?
Yes, you can refinance a home equity loan, but whether it makes sense depends on your credit score, lender requirements, and market rates.
Some homeowners refinance to secure a lower interest rate, extend their repayment terms, or switch from an adjustable-rate mortgage to a fixed-rate loan.
Refinancing a home equity loan might also come with fees and closing costs, so it’s important to compare offers and make sure you’re getting the best deal.
If market conditions have changed, a HELOC or even a cash-out refinancing could be a better choice for your needs.
Will I Lose My Home Equity When I Refinance?
Refinancing doesn’t erase your home equity, but it does reduce how much you have available. Every time you borrow against your home’s value, you take on more debt, which means you own less of your property outright.
For example, if you have $150,000 in equity and take out a cash-out refinance or home equity loan for $50,000, you’ll only have $100,000 in remaining equity.
That might not seem like a big deal, but if market rates shift or home values drop, you could end up owing more than your home is worth—a situation known as being underwater on your mortgage.
That’s why it’s smart to borrow only what you need and leave yourself some cushion in case the housing market fluctuates. If you’re unsure about your best option, a mortgage lender can help you explore the right loan option for your situation.
How Are Cash-Out Refinances and Home Equity Loans Alike?
Both options let you tap into your home equity and turn it into cash, but they share a few key similarities that are important to understand.
Fast Access to Your Funds
A cash-out refinance and a home equity loan both provide a way to access your home’s equity relatively quickly.
Whether you need to pay for home improvements, debt consolidation, or other major expenses, these options give you a straightforward way to use the value you’ve built in your home.
Your Home Secures the Loan
Since both options use your home as collateral, missing monthly payments puts you at risk of foreclosure.
While these loans offer lower interest rates than credit cards or personal loans, it’s important to borrow responsibly and ensure your financial situation allows for steady repayment.
You Can’t Borrow Your Full Home Equity
Most lenders won’t let you borrow 100% of your home’s value. Instead, borrowing limits usually range from 80% to 90%, depending on factors like your credit score, loan-to-value ratio, and market conditions.
How Do Home Equity Loans and Cash-Out Refinances Differ?
While both options let you borrow against your home equity, they work in very different ways.
A Cash-Out Refinance Replaces Your Mortgage, a Home Equity Loan Adds to It
A cash-out refinance replaces your current mortgage with a new mortgage loan, often with a larger loan amount that includes cash you can use for various purposes.
A home equity loan, on the other hand, is a separate loan in second lien position, meaning you’ll have two monthly payments—one for your primary mortgage and another for the home equity loan.
Cash-Out Refinances Usually Have Lower Interest Rates
Since a cash-out refinance replaces your existing mortgage, it typically comes with a lower mortgage rate than a home equity loan or HELOC.
Because lenders see cash-out refinancing as less risky than a second mortgage, borrowers with a high credit score may qualify for lower rates. However, a cash-out refi comes with closing costs, just like when you first took out your mortgage loan.
When a Cash-Out Refinance Is the Right Choice
A cash-out refinance might be the better option if:
- You aim to potentially lower your interest rate: If current mortgage rates are lower than your existing rate, refinancing can reduce your interest costs. However, this depends on market conditions and your credit profile.
- You plan to stay in your home long enough to offset the fees and closing costs.
- You need a larger loan amount for major expenses like debt consolidation, medical bills, or a home project.
If market rates are low and your financial situation allows it, this could be a great way to free up money while keeping a single monthly payment.
When a Home Equity Loan Might Be a Better Fit
A home equity loan could be the right choice if:
- You want a fixed-rate loan with predictable repayment terms.
- You need a lump sum but want to keep your current mortgage loan unchanged.
- You prefer to avoid the closing costs and refinance mortgage fees associated with cash-out refinancing.
This loan option works well for homeowners who want to access their equity without changing their original mortgage. It’s often used for home improvements, investment opportunities, or other financial needs where a fixed payment structure is preferred.
Home Equity Loan Vs. Cash-Out Refinance: Which Is Better?
The right choice depends on your financial needs. If you want the lowest rate and are comfortable replacing your current mortgage, a cash-out refinance might be the better option. If you need cash but want to keep your first mortgage, a home equity loan could be a good idea.
No matter which loan option you choose, it’s important to compare competitive rates, evaluate market conditions, and consider the factors that impact your financial situation.
At Rate, we make it easy to access your home’s equity with options tailored to your needs. Start your journey with a cash-out refinance or see how a HELOC can give you the flexibility to use your equity your way
Using funds from a Cash-out Refinance to consolidate debt may result in the debt taking longer to pay off as it will be combined with borrower’s mortgage principle amount and will be paid off over the full loan term. Contact Rate, Inc. for more information
*Rate, Inc. does not provide tax advice.
