Cash-Out Refinance vs Home Equity Loan

Cash-Out Refinance vs Home Equity Loan: Which Is Right for You?

You have equity in your home and you need cash. Maybe it is for renovations, debt consolidation, college tuition, or an investment opportunity. Two of the most common ways to access that equity are a cash-out refinance and a home equity loan. They both let you borrow against your home, but they work very differently.

How a Cash-Out Refinance Works

A cash-out refinance replaces your existing mortgage with a new, larger one. The difference between the old loan balance and the new loan amount is paid to you in cash at closing.

For example, if your home is worth $500,000 and you owe $250,000, you might refinance into a new $350,000 loan. After paying off the original $250,000 balance, you receive $100,000 in cash (minus closing costs).

Key characteristics of a cash-out refinance:

• You get one new mortgage with one monthly payment
• The new loan typically has a 30-year term, though 15 and 20-year options exist
• Your interest rate applies to the entire loan balance, not just the cash-out portion
• Closing costs are similar to a purchase mortgage, typically 2% to 5% of the loan amount
• Most lenders limit you to 80% loan-to-value, meaning you must keep at least 20% equity
• VA loans allow cash-out up to 100% LTV for eligible veterans

How a Home Equity Loan Works

A home equity loan is a second mortgage. Your original mortgage stays in place, and you take out an additional loan secured by your home equity. You receive the funds as a lump sum and repay it with fixed monthly payments over a set term, typically 5 to 30 years.

Using the same example: you keep your existing $250,000 mortgage and take out a $100,000 home equity loan on top of it. You now have two monthly payments.

Key characteristics of a home equity loan:

• Your first mortgage stays untouched, preserving your existing rate
• Fixed interest rate and fixed monthly payments
• Lower closing costs than a full refinance, sometimes minimal
• Combined loan-to-value (first mortgage plus equity loan) typically capped at 80% to 90%
• Shorter application and closing process compared to a refinance
• Interest may be tax-deductible if funds are used for home improvements

The Rate Factor: This Changes Everything

Here is the most important consideration most people overlook. If your current mortgage rate is well below today's market rates, a cash-out refinance forces you to give up that low rate on your entire balance. A home equity loan lets you keep it.

Say your current mortgage is at 3.5% and today's rates are 6.5%. A cash-out refinance means your full $350,000 balance is now at 6.5%. A home equity loan means only the $100,000 second mortgage is at the higher rate, while your $250,000 first mortgage stays at 3.5%. The monthly payment difference can be hundreds of dollars.

On the flip side, if your current rate is at or above today's rates, a cash-out refinance lets you access cash and potentially lower your rate at the same time. In that scenario, consolidating into one loan at a better rate makes more sense.

Home Equity Line of Credit: The Third Option

A HELOC is worth mentioning because it fills a different need. Like a home equity loan, it is a second mortgage. But instead of a lump sum, it works like a credit card. You have a credit line you can draw from as needed during a draw period (typically 10 years), and you only pay interest on what you use.

HELOCs usually have variable interest rates, which means your payment can change. They work well for ongoing expenses like a phased renovation or uncertain costs, but they are riskier if rates rise significantly.

Side-by-Side Comparison

• Number of payments: Cash-out refi gives you one. Home equity loan gives you two.
• Impact on existing rate: Cash-out refi replaces it. Home equity loan preserves it.
• Closing costs: Cash-out refi is higher (2-5% of full loan). Home equity loan is lower.
• Time to close: Cash-out refi takes 30-45 days. Home equity loan can be faster.
• Rate type: Both offer fixed rates. HELOCs are variable.
• Maximum LTV: Cash-out refi typically 80%. Home equity loan 80-90% combined.

When to Choose a Cash-Out Refinance

• Your current mortgage rate is equal to or higher than today's rates
• You want to simplify into one monthly payment
• You need a large amount of cash and want a longer repayment term
• You want to reset your mortgage term

When to Choose a Home Equity Loan

• Your current mortgage rate is significantly below today's rates
• You need a specific, known amount of cash
• You want lower closing costs
• You prefer to keep your first mortgage intact

What to Watch Out For

Both options use your home as collateral. If you cannot make the payments, you risk foreclosure. Borrow only what you need and what you can comfortably repay. Using home equity for depreciating assets or lifestyle expenses is generally not advisable.

Also compare the total cost of each option over the full repayment period, not just the monthly payment. A lower monthly payment spread over 30 years can cost significantly more in total interest than a higher payment over 15 years.

Want to run the numbers on both options for your specific situation? SOMA can help you compare a cash-out refinance against a home equity loan so you can see which one actually saves you money.