Cash-Out Refinance vs. Home Equity Loan: Which Is Better?

If you’re interested in tapping into your home equity, you have two choices:

1. A cash-out refinance allows you to pull the equity from your home in cash while getting a new first mortgage. 
2. A home equity loan or line of credit (HELOC) allows you to borrow against your equity by taking on a second mortgage. 

Both use your home as collateral, but which option is right for you? Here’s how to compare a cash-out refinance with a home equity loan. 

In this guide:

• What is a cash-out refinance?
• What is a home equity loan?
• Is a cash-out refinance or home equity loan better?
• Is a cash-out refinance or home equity loan cheaper?

What is a cash-out refinance?

A cash-out refinance involves taking out a new, larger first mortgage and withdrawing your home’s equity in cash. You can then use that cash for any purpose, including debt consolidation, home repairs, or unexpected expenses. 

A cash-out refinance is not a second mortgage you pay alongside your primary mortgage. Instead, you replace your home loan with a new mortgage.

Key characteristics of cash-out refinance loans include:

• Loan limits. Most lenders allow you to borrow up to 80% of the home’s value. Cash-out refinancing for VA loans allows you to borrow up to 100% of the home’s value.
• Interest rates. Rates are generally fixed, though certain lenders may offer an adjustable-rate mortgage option for cash-out refinancing. 
• Repayment terms. Depending on the lender, you may be able to get a cash-out refinance loan with a term of up to 30 years. 
• Interest deduction. The interest you pay on cash-out refinance loans is tax-deductible if you use the cash you withdraw to “’buy, build, or substantially improve” the home that’s secured by the loan. 
• Fees. Cash-out refinance loans have closing costs like any other type of home loan. Typical closing costs are 2% to 5% of the loan amount.
• Eligibility. In addition to having sufficient equity in your home, you’ll also need to meet the lender’s minimum credit score requirements. Most lenders require a score of 620 or higher. 

Is a cash-out refinance loan a good way to access home equity? We recommend weighing the pros and cons.

Cash-out refinance pros	Cash-out refinance cons
You may qualify for a lower interest rate on your new mortgage. It may be a less expensive way to borrow than personal loans, lines of credit, or credit cards. A longer repayment term could lower your monthly mortgage payment.	It may be less attractive in an environment where interest rates are rising. Creates more debt since you’re taking out a larger mortgage. Extending your mortgage term could mean paying more interest overall.  The mortgage payment could be higher depending on the amount you cash out.

Here’s an example: 

Imagine your home is worth $350,000, and you owe $150,000 on the mortgage. If you subtract the mortgage balance from the value, you’d have $200,000 in equity. 

Now how much could you borrow? Most lenders look for a combined loan-to-value ratio (CLTV) of 80% or less. 

(Balance of all secured loans on the property / Home value) x 100 = CLTV

Eighty percent of your home’s $350,000 value is $280,000. 

So you may be eligible to borrow up to $130,000 of your equity ($280,000 minus the $150,000 you owe on the mortgage). Most lenders prefer that you have at least 20% equity in the home as it makes the loan less risky. 

What is a home equity loan?

A home equity loan is a second mortgage you take out against your home equity. Home equity loans are installment loans, meaning you pay them back in installments with interest. 

Meanwhile, a HELOC is a revolving credit line that you can draw against as needed. 

The list below includes the key characteristics of home equity loans that differ from cash-out refinance loans:

• Loan limits. Most lenders allow you to borrow up to 80% of the home’s value, though some may increase this to 85% or 90%. 
• Interest rates. Like a cash-out refinance, rates for home equity loans are generally fixed, while most HELOC rates are variable. 
• Repayment terms. Most home equity loans are shorter, repayable over five to 20 years. Many HELOCs have a 10-year draw period, followed by a 20-year repayment period. 
• Fees. Home equity loans and HELOCs can also have closing costs, but certain lenders may waive them or allow you to roll them into the loan.

Like a cash-out refinance, home equity loans and HELOCs qualify for an interest deduction if the money is used to “buy, build, or substantially improve” the home secured by the loan. In addition, the eligibility requirements for home equity loans and HELOCs are similar.

Here are the main advantages and disadvantages of home equity loans and HELOCs: 

Home equity loan and HELOC pros	Home equity loan and HELOC cons
Tap into your equity for any purpose.  You may be able to withdraw more of your equity with a home equity loan than with a cash-out refinance.  No closing costs with certain home equity loans or HELOCs.	Rates tend to be higher than first mortgage interest rates.  Two mortgage payments could put added strain on your budget.  A variable interest rate could make the loan more expensive and your payments higher if the rate increases.

Here’s an example of how a home equity loan works using the same mortgage numbers from the previous example, but the lender allows a CLTV of 85%. 

All else equal, you may be able to borrow as much as $147,500 with a home equity loan. 

That assumes you have an excellent credit score and meet the lender’s other requirements. Comparing this example to the previous one, you might get more equity out of your home with a home equity loan vs. a cash-out refinance. 

Is a cash-out refinance or home equity loan better?

Cash-out refinancing, home equity loans, and HELOCs are three different ways to achieve the same goal: withdrawing your equity. Which one makes the most sense depends on several factors, including:

• How much equity is in the home
• Your credit score and overall creditworthiness
• How much equity you’d like to borrow
• Whether you’re comfortable having a second mortgage
• How much cash you might need to pay closing costs
• What you can afford to pay back

Comparing what they have in common and how they differ side-by-side can help you to decide which option may be preferable for your situation. 

Cash-out refinancing and home equity loan similarities	Cash-out refinancing and home equity loan differences
Both allow you to borrow against your equity, using your home as collateral.  Both can provide you with a lump sum of money that you’re free to use any way you’d like. Both limit how much equity you can withdraw.	A cash-out refinance loan is a first mortgage, while a home equity loan is a second mortgage.   Repayment terms may be longer for cash-out refinancing.  Cash-out refinance loans may offer lower interest rates.

A home equity loan may be more appropriate for borrowers with short-term cash needs who can afford to repay the loan faster. 

Cash-out refinance may be best for borrowers who would rather have one monthly mortgage payment rather than two. 

Remember: Your home secures the loan, regardless of which you choose. If you default on payments, the lender may initiate foreclosure proceedings. It’s important to consider how having a second mortgage payment to a home equity loan might affect your budget. 

Is a cash-out refinance or home equity loan cheaper?

Cash-out refinancing may be a less expensive way to borrow because interest rates tend to be lower than home equity rates. That makes sense: First mortgage loans often have lower rates as they’re less risky for the lender. 

Closing costs may be higher for a cash-out refinance loan since you’re taking out one mortgage that includes your existing mortgage balance plus the equity you’re withdrawing. 

With a home equity loan, you only pay closing costs on the equity you borrow. You pay closing costs on the full HELOC no matter how much you access, but certain lenders will waive these fees on the latter two options.

If you’re considering either option, check out our guides to the top cash-out refinance companies and the best home equity loans.