A cash-out refinance and a home equity loan both let you borrow against the equity in your home, and both put cash in your pocket. The difference is what happens to the mortgage you already have.
A cash-out refinance replaces it with a bigger loan. A home equity loan leaves it alone and adds a second one. That distinction drives your rate, your closing costs, and how many payments you're making.
What's the difference between a cash-out refinance and a home equity loan?
A cash-out refinance replaces your existing mortgage with a new, larger one. The difference comes to you as a lump sum at closing. This option makes the most sense when interest rates have fallen and you want to lock in a lower rate and get cash out.
A home equity loan sits on top of your existing mortgage, which is why it's often called a second mortgage. Your original mortgage stays as-is, and you receive a lump sum. This option makes the most sense when you want to hold on to your current mortgage rate.
At a glance: Cash-out refinance vs. home equity loan
How a cash-out refinance works
This is best illustrated with an example. Say you owe $200,000 on a home worth $350,000:
- Home value: $350,000
- Current mortgage: $200,000
- New mortgage (80% of home value): $350,000 × 0.80 = $280,000
- Cash out: $80,000 ($280,000 − $200,000)
- Closing costs (2-5% of loan): $5,600–$14,000 ($280,000 × 2-5%)
- Net cash at closing: ~$74,400 to $66,000 ($80,000 − closing costs)
Many lenders cap borrowing at 80% of your home's value to keep a cushion if prices fall. This limit is also why closing costs matter: They come out of your proceeds at closing, so the cash you actually receive is lower than the $80,000 the math suggests.
Qualifying for cash-out refinancing works like a standard mortgage. You’ll undergo a credit check, income verification, and a home appraisal. After closing, one monthly payment covers your full balance.
How a home equity loan works
Say you owe $200,000 on a home worth $350,000:
- Home value: $350,000
- Current mortgage: $200,000
- Combined borrowing limit (85% of home value): $297,500 ($350,000 × 0.85)
- Max you can borrow: $97,500 ($297,500 − $200,000)
In this example, 85% is your combined loan-to-value limit, which is the max many lenders allow across both loans (your mortgage and the home equity loan). However, the actual amount may be lower depending on your overall financial picture and the lender's guidelines.
To qualify, you'll go through a hard credit check, income verification, and a home appraisal. Closing costs are often waived, but some lenders charge them on larger loan amounts or second properties. They may also be charged if you pay your home equity loan off too early.
After closing, you'll have two monthly payments: your original mortgage and the home equity loan.
Cash-out refinance vs. home equity loan
Pros and cons of a cash-out refinance
Pros
- Potentially lower rate. If rates have dropped since you bought your home, you could lock in a lower rate on your entire mortgage, not just the cash you're taking out.
- One monthly payment. Simpler to manage than carrying two separate loans.
Cons
- Replaces your existing mortgage. You're starting over with a new, larger loan, which usually means higher monthly payments and less equity than you had before.
- Rates may be higher than when you bought. If rates have gone up, refinancing means paying a higher rate on your full mortgage amount, not just the cash out.
- Higher closing costs. Calculated on the full loan amount, closing costs can easily run into the thousands.
- You need to stay put to break even. Closing costs take time to make back. If you sell before you hit your break-even point, you could end up losing money.
- Higher risk of foreclosure. Higher monthly payments on a bigger mortgage means less cushion in your budget, increasing the chances of falling behind.
How to calculate your refinancing break-even point
To get your break-even point, divide your total closing costs by how much you'll save each month with a new, lower rate. This is how many months it takes before the refinance starts paying off. If you plan to move before hitting that number, refinancing probably isn't worth it.
For example: $10,000 in closing costs ÷ $200/month in savings = 50 months, or just over four years.
Note this only works if your payment is actually lower. With a cash-out refinance, a bigger balance can mean a higher payment, even at a better rate.
Pros and cons of a home equity loan
Pros
- Leaves your existing mortgage alone. If you locked in a low rate, you get to keep it. You're only borrowing against your equity, not replacing your current mortgage.
- Predictable payments. The fixed rate means you know exactly what you owe each month and when the loan ends.
- Closing costs are often waived. Many lenders waive closing costs and fees, especially on loans under a certain amount.
Cons
- A second monthly payment. You'll have an additional payment on top of your existing mortgage.
- Slightly higher interest rate. Lenders take on more risk being second in line, so rates on home equity loans tend to run a bit higher than first mortgages.
- Both loans come out of the proceeds if you sell. Your home equity loan gets paid off at closing when you sell, which reduces what you walk away with.
- Higher risk of foreclosure. A second payment tightens your budget, and because both loans are secured by your home, falling behind on either one puts it at risk.
Read more >> How Soon Can You Refinance Your House?
Cash-out refinance vs. home equity loan: Which is right for you?
How your credit score affects both options
A general rule holds for both options: a higher score usually means a lower rate. But where that rate applies makes a difference.
- With a cash-out refinance, your score affects the rate on your entire new mortgage balance. On a $300,000 loan, even a 0.5% or 1% rate difference can add or save you tens of thousands of dollars over the life of the loan.
- With a home equity loan, your score affects the rate on the second loan only. On a $50,000 loan, that same 0.5% or 1% rate difference is meaningful, but the impact stays contained to a smaller balance.
If your credit needs work before you apply, the two biggest levers are on-time payments and keeping your credit utilization low.
Read more >> How to Refinance a Mortgage With Bad Credit
Bottom line
When choosing cash-out refinance or a home equity loan, the decision usually comes down to your current mortgage rate. If it's low, a cash-out refinance means giving it up on the entire balance, and a home equity loan leaves it alone. If your existing rate is high, refinancing the whole thing may be the cheaper path.
Either way you're putting your house behind the debt, which risks losing your home to foreclosure if you can't repay what you borrow. Consider talking with a financial advisor or nonprofit credit counselor before you sign. The National Foundation for Credit Counseling (NFCC) can connect you with free or low-cost guidance at 800-388-2227.
Whichever loan you choose, stronger credit can help you get a lower rate. Kikoff's Credit Account reports your on-time payments to all three credit bureaus, building the payment history lenders look for. No credit check to join, and plans start at $5 a month.
Frequently Asked Questions
Article Sources
Disclaimer: The information provided in this blog post is meant for informational purposes only and does not constitute financial advice.
