Cash-out refinance vs. home equity loan: The differences

You've built up serious equity in your home — and now you're ready to put that money to work. 

A cash-out refinance and a home equity loan are two great options for tapping into those funds, but choosing the wrong one could cost you thousands in extra interest and fees. It all depends on your financial situation.

Let’s explore the difference between a refinance and a home equity loan and which option might be best for you.

Cash-out refinancing explained

A cash-out refinance, also called a cash-out refi or c/o refi, replaces your existing mortgage with a new, larger loan and gives you the difference in cash. For example, if you owe $200,000 on your current mortgage and your home is worth $400,000, you could refinance for $300,000, pay off your original loan, and receive $100,000 in cash. You then make monthly payments on the new $300,000 mortgage. 

Cash-out refinance pros

A cash-out refinance offer several advantages that make them attractive for many homeowners. Here are the biggest benefits:

— Lower interest rates than other debt: Cash-out refinances typically offer lower interest rates than credit cards or personal loans because your home secures them.

— Flexible use of funds: You can use the cash for any reason, including home improvements, debt consolidation, education expenses, or investment opportunities.

— Potentially lower monthly payments: If refinance rates are lower than your existing mortgage rate, you might reduce your monthly payment even after taking cash out.

— Single monthly payment: You only have one mortgage instead of managing multiple debt payments.

— Tax advantages: Interest may be tax-deductible if you use the funds for home improvements that increase your property's value.

Cash-out refinance cons

Before you jump into a cash-out refinance loan, you need to understand the potential downsides. These drawbacks could impact your decision:

— Higher total interest costs: You restart your mortgage term, potentially paying more interest over the life of the loan.

— Closing costs: Refinancing comes with closing costs ranging from 2%–6% of the loan amount, which might not be worth it depending on how long you plan to own the home.

— Risk of losing good terms: If today's rates are higher than what you're paying now, refinancing means you pay more interest every month.

— Stricter qualification requirements: Lenders require higher credit scores and lower debt-to-income ratios for cash-out refinances.

— Reduced home equity: Taking cash out reduces the equity stake you have in your home.

Home equity loans explained

A home equity loan is a second mortgage that allows you to borrow against your home's equity while keeping your original mortgage intact. You receive a lump sum of money upfront and repay it with fixed monthly payments over a preset term, usually 10–30 years. The loan amount is based on your home's current value minus what you still owe on your primary mortgage. 

It’s always a good idea to weigh the pros and cons of a home equity loan before taking on new debt. 

Home equity loan pros

These loans offer unique advantages that could make them the smarter choice for your situation. Here are the benefits of this type of second mortgage:

— Fixed interest rates: Most home equity loans offer fixed rates, which provide predictable monthly payments throughout the loan term.

— Keep your existing mortgage: You get to keep your current mortgage rate and terms. If you locked in a 3% rate a few years ago, you won't have to give that up for today's higher rates.

— Lower closing costs: Home equity loans typically have lower closing costs than refinancing your mortgage.

— Faster processing: The application and approval process is often quicker than a full mortgage refinance.

— Tax benefits: Interest may be tax-deductible when used for qualifying home improvements.

Home equity loan cons

Home equity loans come with potential terms you need to understand before signing. These risks could impact your finances:

— Your home is collateral: Failure to repay the loan could result in foreclosure, putting your home at risk.

— Higher interest rates: Home equity loans carry higher interest rates than first mortgages or cash-out refinances.

— Two monthly payments: You need to manage payments on your primary mortgage and the home equity loan, which requires extra budgeting and organization.

— Must be repaid upon sale: You need to repay the entire home equity loan when you sell your home, reducing the money you walk away with.

Cash-out refinance vs. home equity loan: Key differences

After weighing the cash-out refinance pros and cons alongside a home equity loan, you can figure out which option suits your needs. Check out this chart to give you a more comprehensive view of each option.

Aspect	Cash-out refinance	Home equity loan
Interest rates	Generally lower rates similar to first mortgages	Typically higher rates than first mortgages
Rate type	Fixed or adjustable options	Usually fixed
Closing costs	Higher	Lower
Monthly payments	Single mortgage payment	Two separate payments
Maximum debt-to-income	Typically 43–50%	Usually 43% or lower
Credit score required	Usually 620+ for conventional loans	Often 660+ required

If you’re not sure which to choose, let Better do the math. Use their 3-minute online pre-approval and Better’s tech will lay out all the options and provide the best recommendation for you based on your goals and financial situation. Better offers cash-out refinances, home equity loans, and other home equity options with competitive rates and a streamlined digital process. The platform allows you to compare rates for both options, helping you make an informed decision based on current market conditions and your financial situation.

Which one should you choose?

Picking between a home equity loan and a refinance comes down to your current mortgage rate, how much cash you need, and how long you plan to stay in your home. Here are the factors to think about:

— Your current mortgage rate: If your rate is below current market rates, a home equity loan preserves your favorable terms.

— How much cash you need: Larger amounts favor cash-out refinances due to better rates, while smaller amounts might work better with home equity loans.

— Your timeline: Home equity loans often process faster if you need funds quickly.

— Total borrowing costs: Compare the total costs, including interest rates, fees, and closing costs, over the expected repayment period.

— Your credit score and debt-to-income ratio: A better financial track record means access to better interest rates and more financing options.

— Tax implications: Interest may or may not be deductible depending on how you use the funds. 

— Your long-term housing plans: If you plan to move soon, you might want to avoid restarting a 30-year mortgage with a cash-out refinance.

— Payment preference: Decide if you prefer one combined payment or can manage two separate monthly payments.

— Risk tolerance: Consider your comfort level with potentially losing favorable mortgage terms versus taking on additional monthly debt obligations.

Choose a cash-out refinance if you:

— Have a current mortgage rate higher than today's rates

— Want to simplify finances with a single monthly payment

— Need a large amount of cash and qualify for competitive rates

— Want to consolidate high-interest debt while potentially lowering your monthly payment

— Plan to stay in your home long-term and can benefit from better mortgage terms

— Don't mind paying higher closing costs for better overall terms

And go for a home equity loan if you:

— Have a low interest rate on your existing mortgage that you want to keep

— Need cash quickly with faster processing times

— Need a smaller amount of money

— Want to avoid the higher closing costs of refinancing

— Plan to move within the next few years and don't want to restart a 30-year mortgage term

— Qualify for favorable home equity loan terms despite having two monthly payments

Access your home equity today with Better

Cash-out refinances and home equity loans offer valuable ways to access your home's equity, but they serve different financial needs and situations. The decision comes down to your situation, current mortgage terms, and financial goals. On top of that, you may even look into a second mortgage, home equity line of credit (HELOC), or home refinance instead. 

No matter what direction you choose, let Better guide the way. Better offers a variety of financing options with great rates and a digital process that’s easy to use — no confusing paperwork or waiting around. Start your 3-minute pre-approval.

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