Home equity can give you access to funds without selling your property, yet the way you borrow against that equity can have a major effect on your mortgage and household budget.
Two common choices are a cash-out refinance and a home equity loan. Both use your property as security, yet they handle your existing mortgage differently.
With a cash-out refinance, your current first mortgage is generally paid off and replaced with a larger mortgage. Part of the new loan pays the old mortgage balance, while the remaining eligible proceeds are paid to you after applicable costs.
A home equity loan, by comparison, generally lets you borrow a lump sum secured by your available home equity without replacing your existing first mortgage. If you already have a mortgage, the home equity loan typically becomes a second mortgage with a separate payment. The Consumer Financial Protection Bureau describes home equity loans as loans secured by home equity and notes that borrowers generally receive the proceeds as a lump sum.
That structural difference should sit near the top of any cash-out refinance vs home equity loan decision.
Cash-Out Refinance vs Home Equity Loan at a Glance
| Feature | Cash-Out Refinance | Home Equity Loan |
|---|---|---|
| Existing mortgage | Usually replaced | Usually remains in place |
| New debt | New first mortgage | Usually separate second mortgage |
| Funds | Cash received from eligible equity after paying applicable obligations and costs | Lump-sum loan |
| Number of mortgage payments | Usually one new mortgage payment | Usually first mortgage plus home equity loan payment |
| Rate effect | Reprices the refinanced first mortgage | Existing first-mortgage rate generally remains unchanged |
| Interest structure | Depends on the mortgage selected | Often fixed, though structures can vary |
| Closing expenses | Mortgage closing costs generally apply | Upfront fees and costs may apply |
| Property at risk | Yes | Yes |
| Best suited to | Situations where replacing the existing mortgage makes financial sense | Situations where keeping the existing first mortgage may be preferable |
Actual pricing, eligibility, loan-to-value limits, fees, and available loan structures vary by lender and loan program.
Which Option May Make Sense?
A simple starting point is to look at your existing mortgage.
A cash-out refinance may deserve attention when replacing your current mortgage would still leave you with acceptable borrowing costs and payment terms. This can be especially relevant when current refinance terms compare favorably with the mortgage you already have.
A home equity loan may deserve attention when you want a lump sum while keeping your existing first mortgage unchanged.
For example, a homeowner with a first mortgage carrying favorable terms may hesitate to replace the entire loan solely to access equity. A separate home equity loan could preserve that first mortgage, although it introduces another loan balance and monthly payment.
The reverse can happen too. If replacing the existing mortgage produces terms that fit your financial situation, consolidating the borrowing into a new first mortgage may be practical.
No single choice works for every homeowner. The total cost of both choices matters far beyond the amount of cash received.
How a Cash-Out Refinance Works
A cash-out refinance is a form of mortgage refinancing in which a new mortgage replaces an existing mortgage and allows eligible equity to be taken out as cash.
Under current Fannie Mae guidance, a qualifying cash-out refinance can pay off the existing first mortgage, certain subordinate mortgage liens, applicable closing expenses, points, prepaid items, and other eligible amounts. Remaining eligible equity may be distributed to the borrower. Specific requirements depend on the mortgage program and transaction.
The process can be understood through a basic hypothetical example.
Assume:
- Your property is valued at $400,000
- Your existing mortgage balance is $180,000
- You qualify for a new $250,000 cash-out refinance
Part of the new loan would pay the $180,000 existing mortgage balance. The remaining amount would then be adjusted for applicable closing expenses, payoff items, and other transaction charges before eligible cash proceeds are distributed.
This example does not suggest that every homeowner can borrow to the same loan-to-value level. Fannie Mae states that allowable LTV ratios depend on factors including mortgage type, property characteristics, occupancy, and underwriting conditions. Individual lenders may apply their own requirements as well.
Advantages of a Cash-Out Refinance
A cash-out refinance may provide several practical benefits:
- One first-mortgage structure. Your old first mortgage is generally paid off and replaced by the new mortgage.
- Access to home equity. Eligible equity can be converted into cash.
- Potential rate change. Refinancing gives you a new mortgage rate based on current pricing and your qualifications.
- Potential term adjustment. Depending on available products, you may be able to change the repayment term or mortgage structure.
The actual benefit depends heavily on your existing loan. Replacing a mortgage with favorable terms can increase borrowing costs even when the cash-out portion itself seems attractive.
Drawbacks of a Cash-Out Refinance
The biggest issue is that you are replacing your existing mortgage.
That can create several tradeoffs:
- Your entire first-mortgage balance receives new financing terms.
- Mortgage closing expenses can apply.
- Your mortgage balance generally increases when you take cash out.
- Extending repayment over a new loan term can affect total interest expense.
- Your home secures the debt, creating foreclosure risk if required payments are not made.
The CFPB identifies origination charges, appraisal expenses, credit-report charges, title insurance, and other applicable expenses as examples of mortgage closing costs. Your Loan Estimate should disclose applicable charges for your transaction.
How a Home Equity Loan Works
A home equity loan lets you borrow against the equity in your property while generally leaving your first mortgage in place.
According to the CFPB, you receive the borrowed amount as a lump sum. Home equity loans often have fixed interest rates, although loan structures can vary. When an existing first mortgage remains on the property, the new loan generally operates as a second mortgage.
Suppose:
- Your home is valued at $400,000
- Your first mortgage balance is $180,000
- A lender approves a $50,000 home equity loan
You would retain the existing $180,000 first mortgage and add the $50,000 home equity loan. The loans would have separate balances, repayment schedules, and potentially different interest rates.
Your combined borrowing would then be evaluated according to the lender's requirements.
Advantages of a Home Equity Loan
A home equity loan may fit borrowers who want to preserve their current first mortgage.
Possible benefits include:
- Your existing first mortgage generally remains unchanged.
- Funds are received in a lump sum.
- Payments may be predictable when the home equity loan has a fixed rate.
- You can compare the new loan independently from your first mortgage.
This structure can be useful when your existing mortgage carries terms you do not want to replace.
Drawbacks of a Home Equity Loan
Adding a second mortgage creates another financial obligation.
Possible disadvantages include:
- A second monthly loan payment
- Additional interest expense
- Potential upfront fees and closing-related expenses
- Reduced available home equity
- Foreclosure risk if the debt cannot be repaid
The CFPB specifically warns that a home equity loan uses your property as collateral. Failure to repay can expose the home to foreclosure. It also advises borrowers to compare upfront costs rather than focusing solely on the monthly payment.
Which Choice Protects Your Existing Mortgage Rate?
This may be one of the biggest deciding factors.
A cash-out refinance replaces your existing first mortgage. That means the cash-out refinance rates available when you apply can affect the entire refinanced balance, not solely the cash you receive.
A home equity loan normally leaves the existing first mortgage intact. You then compare home equity loan rates and loan expenses for the additional amount being borrowed.
Suppose your existing mortgage has terms that you find attractive. Replacing the entire balance could be costly if available refinance pricing is less favorable.
In that situation, paying a different rate on a smaller home equity loan could potentially make financial sense compared with repricing your entire first mortgage.
That conclusion cannot be made from the interest rate alone. APR, loan amount, fees, repayment period, existing mortgage terms, and expected time in the property can all affect the final cost.
Compare Total Borrowing Cost, Not Only Monthly Payments
A lower payment does not automatically mean a less expensive loan.
Longer repayment periods can reduce monthly payments while increasing the amount of interest paid over time. Upfront expenses can also change the economics of a loan.
When comparing cash-out refinance vs home equity loan choices, review:
- Interest rate
- Annual percentage rate
- Loan amount
- Loan term
- Monthly payment
- Origination charges
- Appraisal charges, if applicable
- Title and settlement expenses, if applicable
- Prepayment rules
- Total projected borrowing cost
A cash-out refinance should also be compared with the mortgage you already have. The relevant question is not solely how the refinance compares with a home equity loan. You should assess what you may give up by replacing your current mortgage.
How Much Equity Can You Borrow?
There is no single home-equity percentage that applies to every cash-out refinance or home equity loan.
Maximum borrowing can depend on factors such as:
- Property value
- Current mortgage balance
- Loan program
- Property type
- Occupancy
- Credit profile
- Income and debts
- Underwriting results
- Lender requirements
For conventional cash-out refinances sold to Fannie Mae, allowable LTV levels depend on transaction characteristics and eligibility rules. Fannie Mae's current guidance also includes specific ownership, seasoning, underwriting, and transaction requirements for applicable cash-out refinances.
Home equity loan limits are set according to the lender's program and underwriting standards.
For that reason, statements claiming every borrower can access 80%, 85%, or another fixed percentage of property value should be treated cautiously.
How Loan-to-Value Affects Home Equity Borrowing
Loan-to-value, usually shortened to LTV, compares a mortgage amount with the value of the property securing it.
For a refinance transaction, Fannie Mae generally calculates LTV by dividing the original amount of the new first mortgage by the property's current appraised value, subject to applicable program rules.
When a property has multiple loans, lenders may also evaluate combined loan-to-value measures.
Higher borrowing relative to property value can affect eligibility, pricing, and available loan structures.
That makes an accurate property valuation important when evaluating home equity borrowing options.
What About Taxes?
Homeowners should be careful with claims that interest on home-equity debt is automatically tax-deductible.
IRS guidance states that interest on qualifying home-secured debt may be deductible when the borrowed funds are used to buy, build, or substantially improve the home securing the loan, subject to applicable requirements and limits.
Using proceeds for personal expenses such as paying credit-card debt does not automatically qualify the interest for the home-mortgage interest deduction.
The tax outcome depends on the use of proceeds, loan structure, applicable limits, filing method, and current tax law.
Because individual tax situations vary, tax consequences should be checked against current IRS guidance or discussed with a qualified tax professional.
Cash-Out Refinance vs Home Equity Loan for Home Improvements
Home improvements are a common reason homeowners access equity.
Either financing method could supply funds for a renovation, yet the better financing structure depends on the mortgage you already have and the amount you need.
A cash-out refinance may fit if replacing your existing first mortgage is financially acceptable and you want the equity proceeds incorporated into a new first mortgage.
A home equity loan may fit if you know approximately how much funding you need and want to leave your first mortgage unchanged.
Tax treatment can also depend on how the funds are used. IRS rules may allow qualifying mortgage interest deductions when proceeds are used to buy, build, or substantially improve the home securing the debt, subject to applicable requirements.
What If You Want to Pay Off Other Debt?
Home equity can sometimes be used to repay credit cards, auto loans, or other obligations.
That does not automatically mean doing so will save money.
The CFPB has reported that some cash-out refinance borrowers used proceeds to reduce credit-card and auto-loan debt. The agency also warned that converting non-mortgage debt into mortgage debt can increase foreclosure exposure because the home secures the new borrowing.
Before using either equity option for debt repayment, compare:
- Interest rates
- Repayment periods
- Fees
- Total projected interest
- Monthly cash flow
- The risk created by securing debt with your home
Moving unsecured debt into debt secured by your property changes the consequences of missing payments.
What About a HELOC?
A home equity line of credit, or HELOC, is another way to borrow against home equity.
Unlike a home equity loan, which generally provides a lump sum, a HELOC is a revolving credit line. You can draw funds up to your available limit during the applicable draw period and repay amounts according to the agreement.
The CFPB notes that HELOCs usually have adjustable rates, so payments can change as rates and outstanding balances change.
A HELOC may fit situations where expenses occur gradually rather than all at once. Because this article focuses on cash-out refinancing and home equity loans, a HELOC should be evaluated separately before making a borrowing decision.
Questions to Ask Before Choosing
Before applying, ask yourself:
Do you want to replace your current mortgage?
If not, a home equity loan may fit the structure you want better than a cash-out refinance.
How favorable are your existing mortgage terms?
Compare your current interest rate and remaining term against available refinancing terms.
How much cash do you actually need?
Borrowing beyond your planned need increases your secured debt.
Can your budget handle two housing-related loan payments?
A home equity loan usually creates a separate payment when you already have a first mortgage.
How long do you expect to keep the property?
Upfront expenses may matter heavily if you expect to sell or refinance again within a relatively short period.
What is the total cost?
Compare APR, fees, term, monthly payment, and total projected interest instead of selecting a loan from the advertised rate alone.
Can You Cancel After Closing?
Federal law provides a right of rescission for many non-purchase-money mortgage transactions involving a principal residence, including many refinances and home equity loans.
The CFPB states that eligible borrowers generally have three business days to cancel after the required events have occurred. Exceptions and transaction-specific rules apply.
Review your closing documents carefully so you understand any cancellation rights that apply to your transaction.
Frequently Asked Questions
Is a cash-out refinance the same as a home equity loan?
No. A cash-out refinance generally replaces your existing first mortgage with a new, larger first mortgage. A home equity loan generally creates a separate loan secured by your equity while leaving your first mortgage in place.
Which has lower interest rates?
There is no universal answer. Rates depend on market conditions, loan type, borrower qualifications, property details, lender pricing, and other underwriting factors.
Compare actual loan estimates instead of assuming one product will always carry a lower rate.
Does a home equity loan change your first mortgage?
Normally, no. If you already have a first mortgage, a home equity loan generally becomes a second mortgage.
Does a cash-out refinance change your mortgage rate?
Yes, the refinance creates a new mortgage with new loan terms and pricing. Your old mortgage is generally paid off through the transaction.
Can you use the money for any purpose?
Permitted uses can depend on the loan program and lender. Fannie Mae permits equity proceeds from eligible cash-out refinance transactions to be used for any purpose under its applicable guidelines. Home equity loan terms can vary by lender.
Tax treatment is a separate issue. Using the funds for personal expenses can affect the deductibility of interest.
Can you lose your home with either loan?
Yes. Both types of borrowing are secured by your property. Failure to repay according to the loan terms can lead to foreclosure.
Is a home equity loan always cheaper than refinancing?
No. Costs depend on the amount borrowed, rates, fees, repayment period, existing mortgage terms, and individual loan pricing.
Is a cash-out refinance always better when rates fall?
Not necessarily. The new interest rate is only one part of the calculation. Closing expenses, the new loan term, remaining balance, monthly payment, and total projected interest should all be evaluated.
Choosing Between the Two
The key difference in cash-out refinance vs home equity loan decisions comes down to what happens to your existing mortgage.
A cash-out refinance replaces that mortgage with a new first mortgage and converts eligible home equity into cash.
A home equity loan generally keeps your existing first mortgage in place and adds a separate loan secured by your property.
If preserving your current mortgage terms matters, a home equity loan may deserve closer attention. If replacing your first mortgage works financially and you prefer a single new first-mortgage structure, a cash-out refinance may be worth comparing.
Before signing either loan, compare actual Loan Estimates, APRs, monthly payments, fees, repayment terms, and total projected costs. Most importantly, account for the fact that your home secures the debt.
