If you need cash and have a sizable amount of home equity built up, you may consider a cash-out refinance or a home equity loan.

Both a cash-out refinance and a home equity loan allow you to borrow against your home’s equity, using your home as collateral. A cash-out refinance is the process of replacing your existing mortgage with a new one, while a home equity loan is a second loan you take out on top of your mortgage.

Before deciding which of these home equity products is right for you, consider the benefits and risks of both options in addition to researching individual lenders.

What are the similarities and differences between a cash-out refi and a home equity loan

A home equity loan and a cash-out mortgage refinance can be used for similar purposes, like funding a major home improvement project or paying off high-interest debt. Both also use the property as collateral, which puts it at risk of foreclosure if you default on either loan.

While cash-out mortgage refinances and home equity loans serve similar purposes, there are some important differences. A cash-out refinance is the process of taking out a loan to pay off the remaining balance on your mortgage, effectively replacing your mortgage with a new loan. A home equity loan is a second mortgage that comes with a separate set of terms and its own interest rate.

Cash-out refinance

A cash-out refinance pays off the remaining balance on your first home loan and replaces it with a new mortgage loan. The newly refinanced loan amount is for the remaining debt owed on the first mortgage, plus the amount you’re “cashing out” from the equity.

Cash-out refinancing may have a different interest rate than what you currently have, and the loan term is generally up to 30 years.

Some lenders and federal programs may set lower credit score requirements for cash-out refinancing. Because the refinancing lender assumes the first mortgage during a cash-out refi, that lender becomes the primary lienholder in the event of a default. With easier access to your home as collateral, lenders might be willing to offer lower rates compared to what you’ll get with a home equity loan.

Pros Cons
Lower credit scores may still qualify. There is foreclosure risk if the loan is not paid.
Cash-out refi is one loan to manage instead of several. Underwriting a new mortgage is time-consuming.
The borrower’s credit score benefits. The borrower must have at least 20% equity.
Iinterest rates are typically lower than the current credit card interest rate. Closing costs can be high.
Cash-out refinances help consolidate debt. The borrower must have a low debt-to-income ratio.
  • Takeaway: A cash-out refinance can be an option for homebuyers to borrow a lump sum for planned expenses, and you’ll only have a single mortgage to track.
  • Who it’s best for: Borrowers who don’t have excellent credit might have a better chance of getting approved for a cash-out refinance.

Home equity loan

A home equity loan is often regarded as a way to fund big-ticket purchases, make costly home upgrades and consolidate high-interest debt.

It’s a second mortgage against your home with its own terms and interest rate that are separate from your first mortgage. By refinancing using a home equity loan, you’re borrowing against the home’s equity — the difference between the market value of your home and what you owe on your mortgage. You can typically borrow up to 85 percent of your home’s equity. However, your loan amount is also contingent on other financial factors, like your income and credit history.

Home equity loan rates may be higher than other refinancing options. The differences, however, vary significantly from bank to bank and over time. Home equity loans typically have a repayment period of up to 30 years.

Some lenders may not charge origination fees, which results in lower (or no) closing costs. Home equity loans also don’t require mortgage insurance, unlike some cash-out refinance mortgages.

Pros Cons
Fixed interest rates make it easier for budgets. There is a foreclosure risk if the loan is not paid.
Lower interest rates than personal loans or credit cards make it more affordable. The borrower needs good to excellent credit.
Long repayment terms mean lower monthly payments. The borrower must have substantial equity in the home.
Tax-deductible interest is possible for certain uses. The borrower must pay off the loan balance if they sell the home.
Cash is easily accessible and can be used for almost any purpose. A lump sum payment can result in borrowing more than needed.
  • Takeaway: A home equity loan is an option for those who’ve built up a lot of equity in their homes. More equity in your home means you can borrow a larger amount to pay off your first mortgage while putting any loan surplus toward another expense or financial goal.
  • Who it’s best for: A home equity loan is ideal if you have a strong credit score, assuming you can find a lender that waives home equity loan closing costs. It’s also sensible if you can qualify for a significantly lower interest rate than you have on your current mortgage.

Refinancing with a 15-year cash-out refi vs. a 15-year home equity loan

In this scenario, refinancing with a cash-out refinance loan is cheaper, despite its higher closing costs and loan amount. This is because the cash-out refinance interest rate is significantly lower than the home equity loan rate.
Refi with 15-year cash-out refi Refi with 15-year home equity loan
Loan amount $170,000 $150,000
Closing costs $2,400 $600
Interest rate 2.59% 5.66%
Monthly principal and interest $1,140.76 $1,238.40
Total cost in first 24 months $29,778.24 $30,321.60
Total cost in first 48 months $57,156.48 $60,043.20
Total cost in first 60 months $70,845.60 $74,904

The above scenario illustrates the potential benefits of a cash-out refinance over a home equity loan. Cash-out refinancing tends to come with a lower interest rate than home equity loans. while home equity loans have lower closing costs, they are typically more expensive over time due to higher interest.

If you have good to excellent credit and are able to find a home equity loan with a low interest rate or a lender that waives closing costs, a home equity loan could be the right choice. However, the lower interest rates associated with cash-out refinance is a major advantage.

How to decide which is right for you

Venn-diagram of what cash-out refi and home equity have in common

Ultimately, it’s a personal decision that depends on the amount of equity you have in your home and your credit rating. It’s equally important to consider the qualification criteria for both options to gauge which you’re most likely to get approved for.

A home equity loan could work if you have a strong credit score and wish to pull out a large amount of equity. Still, a cash-out refinance may be the smarter option if you want to reduce your mortgage payment and pull funds from your equity using a single loan product.

The bottom line

A cash-out refinance or home equity loan are both strategic ways to access the equity you’ve built in your home. However, you have to consider your financial situation, goals and how you plan to use the funds to determine the best approach. It’s equally important to consider the qualification criteria for both options to gauge which you’re most likely to get approved for.

A home equity loan could work if you have a strong credit score and wish to pull out a large amount of equity. Still, a cash-out refinance may be the smarter option if you want to reduce your mortgage payment and pull funds from your equity using a single loan product.

Always shop around and compare offers from multiple lenders regardless of which path you choose. Also, request an itemized list of lending fees from the lender you choose so you can calculate how much the loan will cost.

Frequently asked questions

  • There is no limit on how many times you can refinance your home, but you typically have to wait at least six months between cash-out refinances. This is called a “seasoning” period. Different lenders have different requirements.
  • A cash-out refinance is considered a loan, not income, so you will not have to pay taxes on the money you receive. Your cash-out refinance may be eligible for a tax deduction if you use the money to make permanent improvements to the home. This could include projects like putting in a swimming pool, adding a bedroom or bathroom or upgrading the heating and air conditioning system.
  • A no cash-out refinance is the process of refinancing your home for less than or the same amount that you owe on your mortgage, plus closing costs on the new mortgage. This type of refinancing allows you to transfer to a loan with better terms and a lower interest rate, but you do not get new money.
  • Getting a home equity loan can take anywhere from one week to two months, but most lenders advertise an average window of two to six weeks.
  • A home equity loan can be used for virtually anything you want, but it is most commonly used to consolidate debt or finance big purchases. Because these loans tap into your home’s equity, it is smart to use the funds for home improvement, increasing the value of your home. However, it is important to use the funds wisely and make sure you don’t take out more than you need. If you can’t pay back the loan, you may lose your home.

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