As a homeowner, you have a powerful financial resource at your disposal: your equity. Simply put, equity is the portion of your home you truly own. It’s the difference between your property’s current market value and your remaining mortgage balance. By accessing this value, you can fund major life goals, such as home renovations, debt consolidation or educational expenses.
Two of the most common ways to unlock this value are a cash-out refinance and a home equity loan. Let’s look at these two options to help you decide if either could be the right financial tool for you.
Home Equity Loans vs. Cash-Out Refinance
A home equity loan and a cash-out refinance both allow you to convert home equity into liquid funds. However, they function differently and align with distinct financial strategies.
A home equity loan acts as a secondary mortgage, giving you a lump sum of cash while leaving your original mortgage entirely intact. You will make a second loan payment each month in addition to your mortgage.
A cash-out refinance, on the other hand, completely replaces your existing mortgage with a brand-new loan that is larger than your current balance, allowing you to pocket the difference.
To help you understand the differences, here is a comparison chart outlining how each loan type operates:
| Feature | Home Equity Loan | Cash-Out Refinance |
| Loan Type | Second loan (separate from your primary mortgage) | Replaces your existing mortgage entirely |
| Interest Rate | Fixed rate, often higher than a primary mortgage | Typically lower than an equity loan (but resets your full loan rate) |
| Monthly Payments | Two separate payments (original mortgage + equity loan) | One new, combined monthly payment |
| Access to Cash | Lump sum payment | Lump sum payment |
| Impact on Current Mortgage | No change to your original rate or terms | Replaces your current rate and loan term |
| Closing Costs | Generally lower than a full refinance | Higher (similar to standard mortgage closing costs) |
| Best For | Small to mid-sized expenses; keeping a low current rate | Large expenses; securing a lower rate or resetting your loan term |
When a Home Equity Loan Makes Sense
A home equity loan can be beneficial for homeowners who want a predictable, structured way to borrow money without touching their primary mortgage. Here is when it can make sense:
You Already Have A Low Mortgage Rate
If you secured your original mortgage during a period of low interest rates, you likely want to preserve those favorable terms. A home equity loan allows you to borrow the extra funds you need while keeping your primary mortgage untouched. You get to enjoy the benefits of more cash without giving up the great rate you already locked in.
You Want To Avoid Refinancing Your Entire Loan
Refinancing means replacing your current mortgage with a new loan for the full balance, which can come with higher closing costs. If you’re close to paying off your mortgage — or you’re happy with your current rate and terms — a second loan might be a simpler option.
But the Consumer Financial Protection Bureau (CFPB) cautions that since it is a second mortgage, your debt burden does increase. This means you’re taking on additional debt secured by your home, so it’s important to borrow carefully and make sure the payments fit comfortably within your budget.
You Need A Fixed Amount For A Specific Project
Home equity loans provide a single lump-sum payment with a fixed interest rate. This structure can work for homeowners who have a clearly defined budget for a specific expense. Whether it’s a home upgrade, a new deck, or a big life event like a wedding, knowing how much you need can make a home equity loan a good fit.
When a Cash-Out Refinance Makes Sense
A cash-out refinance is a strategy for homeowners looking to streamline their finances and potentially secure better loan terms overall. Let’s break down when it could be a good solution.
Your Current Mortgage Rate Is Higher Than Today’s Rates
If market interest rates have dropped since you originally purchased your home, a cash-out refinance offers a dual benefit. You can access the cash you need while simultaneously lowering the interest rate on your entire mortgage balance. This can result in significant long-term savings.
You Want To Simplify Into One Payment
A cash-out refinance rolls your primary mortgage balance and your newly accessed cash into a single loan. You will have one interest rate and make one monthly payment, which can make things easier to manage.
You need a larger amount of cash
Because a cash-out refinance may offer lower interest rates than a home equity loan, it is often the preferred choice for accessing substantial amounts of capital. If you are planning a whole-home renovation, buying an investment property or consolidating a large amount of high-interest consumer debt, a cash-out refinance generally provides the most cost-effective borrowing terms.
What to Consider
Before moving forward with either option, taking a comprehensive look at your financial picture will help you make an informed and confident choice.
Total Interest Over Time
Always look at the big picture. With a cash-out refinance, you might extend the lifespan of your mortgage, which can mean paying more total interest over time. A home equity loan may come with a higher rate, but it often has a shorter repayment term.
A cash-out refinance may make more sense if you can secure a lower rate or want a single monthly payment. A home equity loan can be a better fit if you prefer to keep your existing mortgage and pay off the new loan more quickly.
Closing Costs vs. Savings
Every financial product comes with associated fees. Cash-out refinances generally carry closing costs ranging from 2% to 6% of the total loan amount. Home equity loans may have comparable or slightly lower closing costs depending on the lender. You will want to calculate whether the savings generated by a lower interest rate on a refinance outweigh the initial closing costs required to secure the loan.
Impact On Your Existing Mortgage Rate
If your existing mortgage rate is significantly lower than the current market average, it can be advantageous to keep it and consider a home equity loan. If rates have dropped since you first took out your mortgage, a cash-out refinance could give you the chance to lower your rate while accessing cash.
Long-Term Plans For The Home
Think about how long you plan to stay in your current house. If you intend to sell the property in the next few years, the closing costs of a cash-out refinance might not pay for themselves before you move. On the other hand, if this is your forever home, you have plenty of time to recoup those costs through lower monthly payments or tax advantages.
Keep in mind that depending on how you use the funds, the interest paid on home equity loans and cash-out refinances used for substantial home improvements may be tax-deductible, according to the Internal Revenue Service (IRS). Speak with a tax professional to understand if you qualify.
Making the Most Of Your Home’s Value
Whether you choose the structured payments of a home equity loan or a cash-out refinance that replaces your existing mortgage, tapping into your home equity can help fund a major expense or consolidate higher-interest debt.
Take time to compare your current mortgage rate, how much you need to borrow and your long-term plans to find the option that fits best. Using a home value calculator can also help you estimate your home’s current worth and better understand how much equity you may be able to access.
