As a homeowner, tapping into your home’s equity can be a smart way to fund major expenses like renovations, debt consolidation, or education costs. Two of the most common options for accessing your home equity are a home equity loan and a cash-out refinance.
While both methods provide a way to convert your equity into usable cash, they differ significantly in structure, costs, and impact on your existing mortgage.
Understanding the key differences can help you make an informed decision based on your financial goals and current mortgage status. Let’s break down the basics of a home equity loan vs cash-out refinance and see how each works.
Structure and Loan Setup
The basic difference you’ll need to know between a home equity loan vs cash-out refinance is their structure and loan setup. A home equity loan is often referred to as a “second mortgage.” It allows you to borrow a fixed amount against your home’s equity, which you repay in equal monthly installments over a set period. Your original mortgage remains unchanged, and this loan is separate, requiring an additional monthly payment.
A cash-out refinance, on the other hand, replaces your current mortgage with a new one. The new mortgage is for more than what you currently owe, and the difference between the new loan amount and your existing loan balance is paid to you in cash. Instead of having two loans, you now have one new mortgage that includes the cash you’ve withdrawn. AmeriSave has a detailed guide on this comparison to help users know the basic differences and then make the choice that suits them.
Interest Rates and Terms
Generally, cash-out refinance loans offer lower interest rates than home equity loans, since they replace your primary mortgage and are considered less risky by lenders. However, this can vary based on market conditions, your credit score, and the size of the loan.
A home equity loan typically has a fixed interest rate, which is helpful for budgeting, but may be slightly higher because it’s a second lien on your property. Meanwhile, cash-out refinance loans can come with either fixed or variable interest rates and new loan terms.
Closing Costs and Fees
Another major difference lies in the upfront costs. A cash-out refinance usually involves higher closing costs—similar to those when you first purchased your home. These can include lender fees, appraisal fees, title insurance, and more, totaling 2% to 5% of the loan amount.
A home equity loan generally has fewer and lower fees, making it a more cost-effective choice if you need a smaller amount of money or don’t want to disturb your current mortgage. However, even these loans can come with application and processing fees, so it’s important to compare total costs.
Best Use Cases for Each Option
A home equity loan is ideal if you have a low interest rate on your existing mortgage and you don’t want to refinance. It works well for borrowers who need a lump sum for a specific purpose, like home improvements or paying off high-interest debt.
A cash-out refinance is more suitable if you can secure a better mortgage rate than your current one or if you’re looking to borrow a larger amount. Since it replaces your mortgage, it’s also a good option if your original loan is nearing the end of its term and you’re comfortable resetting the clock with a new mortgage term.
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