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Cash-Out Refinance vs. Home Equity Loan

A cash-out refinance replaces your existing mortgage with a new, larger loan and returns the difference as cash. A home equity loan adds a second lien while keeping your original mortgage intact. Each option accesses home equity differently, with distinct implications for your interest rate, closing costs, and existing loan terms.

Key Takeaways

  • A cash-out refinance replaces your existing mortgage entirely; a home equity loan adds a second lien while your first mortgage remains unchanged.
  • Cash-out refinance rates are lower (first-lien pricing) but include loan-level price adjustments; home equity loan rates are higher due to subordinate lien risk.
  • Cash-out refinance closing costs apply to the full new loan amount and typically range from 2-5% of the balance; home equity loan closing costs apply only to the second loan amount.
  • If your current mortgage rate is well below market rates, a home equity loan preserves that rate while a cash-out refinance would replace it.
  • Cash-out refinance resets your amortization schedule and loan term; a home equity loan does not affect your existing amortization progress.
  • Lenders evaluate the combined loan-to-value (CLTV) ratio for home equity loans, typically capping total borrowing at 80-90% of home value.
  • Both products require sufficient home equity, a qualifying credit score, and a debt-to-income ratio within program limits.
  • The best choice depends on your current rate environment, the amount of cash needed, and whether you want to maintain or restructure your existing mortgage.

How It Works

How Cash-Out Refinance Works

A cash-out refinance replaces your existing first mortgage with an entirely new loan at a higher principal balance. The new loan pays off your current mortgage, and you receive the difference between the new loan amount and your prior balance as cash at closing. For example, if your home is worth $400,000 and you owe $200,000, a cash-out refinance might create a new $280,000 mortgage. After paying off the original $200,000 balance, you receive approximately $80,000 in cash (minus closing costs).

For related information, see our guides on home equity loans, HELOCs, and second mortgage fundamentals.

Because the new loan fully replaces the old one, every term resets. You receive a new interest rate based on current market conditions, a new amortization schedule (typically 30 years), and new monthly payment amounts. Most conventional cash-out refinances allow a maximum loan-to-value (LTV) ratio of 80%, meaning you must retain at least 20% equity after the transaction. FHA cash-out refinances permit up to 80% LTV, and VA cash-out refinances may allow up to 100% LTV for eligible veterans .

How a Home Equity Loan Differs

A home equity loan is a separate, second mortgage that sits behind your existing first mortgage. Your original mortgage remains completely untouched: same rate, same balance, same remaining term, same monthly payment. The home equity loan provides a lump sum of cash secured by your home equity, repaid on its own fixed schedule with its own interest rate.

Because a home equity loan occupies a subordinate lien position, the lender faces higher risk. If the property goes to foreclosure, the first mortgage is paid before the second lien holder receives anything. This increased risk is reflected in higher interest rates compared to first-lien products. The combined loan-to-value (CLTV) limit for both mortgages typically cannot exceed 80-90% of the home value, depending on the lender and borrower qualifications .

Rate and Cost Comparison

Cash-out refinance rates are first-lien mortgage rates, which are generally lower than second-lien rates. However, cash-out refinance rates carry pricing adjustments (also called loan-level price adjustments or LLPAs) that make them slightly higher than standard rate-and-term refinance rates. The size of the adjustment depends on the LTV ratio and credit score.

Home equity loan rates are higher than first mortgage rates because of the subordinate lien position. The rate premium over first-lien rates typically ranges from 1% to 3% or more, depending on the lender, CLTV ratio, and credit profile .

Closing costs also differ significantly. A cash-out refinance involves full mortgage closing costs (origination fees, appraisal, title insurance, recording fees, and potentially discount points) calculated on the entire new loan amount. These costs commonly range from 2% to 5% of the new loan balance . A home equity loan also has closing costs, but they are calculated on the smaller second loan amount and may be lower in total. Some lenders reduce or waive closing costs on home equity loans to attract borrowers, though these concessions may be recaptured if the loan is paid off within a specified period.

When Cash-Out Refinance Makes Sense

A cash-out refinance is most advantageous when current market rates are lower than your existing mortgage rate. In this scenario, you accomplish two objectives simultaneously: you access cash from your equity and you reduce your interest rate on the entire mortgage balance. Consolidating into a single loan also simplifies your monthly obligations to one mortgage payment with one servicer.

Cash-out refinance may also be preferable when you need a large amount of cash. Because the loan is sized against the full property value as a first lien, you may be able to access more equity than a second-lien product would allow. Borrowers seeking to consolidate high-interest debt, fund major home improvements, or cover significant expenses often find the lower first-lien rate on the full balance more cost-effective over time, even with the closing costs of a full refinance.

When a Home Equity Loan Makes Sense

A home equity loan is typically the better choice when your existing first mortgage carries a low interest rate that you want to preserve. If you locked in a rate significantly below current market rates, refinancing would mean giving up that favorable rate on your entire balance, potentially costing more in total interest over the life of the loan than the savings from accessing equity through a first-lien product.

Home equity loans also suit borrowers who need a smaller, defined amount of cash. Because the loan is separate from the first mortgage, you borrow only what you need without restructuring your primary loan. The fixed-rate, fixed-term structure of a home equity loan provides predictable payments and a clear payoff timeline. This can be advantageous for targeted expenses such as a specific home renovation project, a one-time educational expense, or another discrete financial need.

Impact on Your Existing Mortgage Terms

This is the most consequential difference between the two options. A cash-out refinance completely eliminates your existing mortgage. Every term you negotiated or benefited from (your interest rate, your remaining loan term, your accumulated amortization progress) is replaced. If you are 10 years into a 30-year mortgage, a cash-out refinance resets you to a new 30-year term (though shorter terms are available). The amortization clock restarts, meaning early payments are again heavily weighted toward interest rather than principal.

A home equity loan leaves your first mortgage entirely intact. Your original rate, remaining term, payment amount, and amortization progress are all preserved. The trade-off is carrying two separate monthly payments to two different servicers, which adds complexity to your monthly financial management. Borrowers must evaluate whether the combined monthly payment of the first mortgage plus the home equity loan is sustainable within their budget and debt-to-income ratio limits.

Key Factors

Factors relevant to Cash-Out Refinance vs. Home Equity Loan
Factor Description Typical Range
Lien Position Determines the loan priority claim against the property in the event of default or foreclosure, directly affecting lender risk and loan pricing. Cash-out refinance: first lien. Home equity loan: second lien (subordinate to existing first mortgage).
Interest Rate The annual cost of borrowing, influenced by lien position, market conditions, credit score, and loan-to-value ratio. Cash-out refinance: near prevailing first mortgage rates with LLPAs. Home equity loan: typically 1-3% higher than first-lien rates.
Closing Costs Fees paid at settlement including origination, appraisal, title insurance, and recording charges, calculated on the respective loan amount. Cash-out refinance: 2-5% of the full new loan amount. Home equity loan: costs on the smaller second loan, sometimes reduced or waived.
Impact on Existing Mortgage Whether the transaction modifies or eliminates the current first mortgage terms, including rate, remaining term, and amortization progress. Cash-out refinance: replaces existing mortgage entirely (new rate, new term, reset amortization). Home equity loan: no impact on first mortgage.
Loan Amount Access The maximum cash a borrower can extract, governed by LTV or CLTV limits set by the loan program and lender. VA cash-out refinances are limited to 90% of the appraised value, as established by the Blue Water Navy Vietnam Veterans Act (P.L. 116-23, Section 501), effective for loans closing on or after April 7, 2024..

Examples

Cash-Out Refinance to Lock a Lower Rate

Scenario: A homeowner had a $300,000 mortgage at 7.2% on a home valued at $450,000. Market rates had dropped to 5.9%, so they applied for a cash-out refinance of $350,000 to replace the original loan and extract $50,000 for home improvements.
Outcome: The new loan reduced the monthly payment despite the larger balance, and the homeowner received $50,000 at closing. Total interest savings over the life of the loan offset much of the refinance closing costs.

Home Equity Loan to Preserve an Existing Low Rate

Scenario: A borrower had a first mortgage at 3.25% with a $200,000 balance on a $400,000 property. They needed $60,000 for a major roof replacement. A cash-out refinance would have replaced the 3.25% loan with a new one at 6.8%.
Outcome: The borrower chose a home equity loan at 7.5% for the $60,000 instead. While the second-lien rate was higher, keeping the low-rate first mortgage intact saved them roughly $350 per month compared to refinancing the entire balance.

Cash-Out Refinance With High Closing Costs

Scenario: A homeowner wanted to access $30,000 in equity from a $350,000 property. The cash-out refinance offer came with $8,500 in closing costs including a new appraisal, title insurance, and origination fees on the full $250,000 loan amount.
Outcome: After closing costs, the homeowner netted only $21,500 in usable cash. A home equity loan for the same $30,000 would have carried roughly $2,000 in closing costs, delivering significantly more of the borrowed amount.

Home Equity Loan for a Fixed Repayment Timeline

Scenario: A borrower needed $40,000 for a one-time expense and wanted a predictable repayment schedule. Their first mortgage had 22 years remaining at a favorable rate. They considered both a cash-out refinance resetting to a new 30-year term and a 10-year home equity loan.
Outcome: The borrower selected the 10-year home equity loan. While the monthly payment was higher, the total interest paid was substantially less than stretching the debt over a new 30-year refinance term.

Cash-Out Refinance to Consolidate Multiple Debts

Scenario: A homeowner owed $180,000 on a $380,000 home and carried $55,000 in auto loans and credit card balances at rates ranging from 9% to 22%. They applied for a cash-out refinance of $235,000 at 6.4% to pay off all debts under a single payment.
Outcome: The consolidation eliminated the high-interest accounts and reduced total monthly debt payments by over $600. However, the homeowner converted unsecured debt into debt secured by the home, increasing foreclosure risk if payments were missed.

Common Mistakes to Avoid

  • Refinancing a Low-Rate Mortgage Just to Access Cash

    Replacing a first mortgage at 3-4% with a new loan at 6-7% to extract a relatively small amount of cash dramatically increases interest costs over the remaining loan term. A home equity loan preserves the low first-lien rate and limits the higher rate to only the borrowed amount.

  • Comparing Only the Interest Rates

    A cash-out refinance may offer a lower rate than a home equity loan, but it applies that rate to the entire loan balance, not just the new cash. Borrowers who compare rates without calculating total interest paid over the life of each option often choose the more expensive path.

  • Ignoring Closing Costs on a Cash-Out Refinance

    Cash-out refinance closing costs typically run 2-5% of the full new loan amount, not just the cash-out portion. On a $300,000 refinance to extract $40,000, the borrower may pay $9,000 or more in fees -- consuming a significant share of the funds received.

  • Resetting the Loan Term Without Accounting for Total Cost

    A cash-out refinance often resets the amortization clock to 30 years. A homeowner who was 10 years into their original mortgage and refinances into a new 30-year term will pay interest for 40 total years instead of 30, adding tens of thousands in lifetime interest.

  • Overlooking the Risk of Converting Unsecured Debt to Secured Debt

    Using a cash-out refinance to pay off credit cards turns unsecured obligations into debt backed by the home. If the borrower later defaults, they face foreclosure -- a consequence that would not have applied to the original credit card balances.

  • Failing to Shop Both Products Simultaneously

    Many borrowers approach only their current lender or consider only one product type. Rates, fees, and terms vary significantly between lenders and between cash-out refinances and home equity loans. Obtaining quotes for both products from multiple lenders often reveals a meaningfully better deal.

Documents You May Need

  • Most recent mortgage statement showing current balance, rate, and payment
  • Most recent 30 days of pay stubs
  • W-2s or 1099s for the past two years
  • Federal tax returns for the past two years (all pages and schedules)
  • Bank statements for the past two to three months (all pages)
  • Homeowners insurance declarations page
  • Property tax bill or most recent assessment
  • Government-issued photo identification

Frequently Asked Questions

Can I do a cash-out refinance if my current mortgage rate is lower than today's rates?
Yes, but you will give up your existing lower rate. The new loan replaces your old mortgage entirely, so you will pay the current market rate on the full balance. In this scenario, a home equity loan may be more cost-effective because it preserves your low first-mortgage rate and only applies the higher rate to the additional amount borrowed.
How much equity do I need for a cash-out refinance versus a home equity loan?
For a conventional cash-out refinance, you typically need to retain at least 20% equity after the new loan is funded (80% maximum LTV). For a home equity loan, lenders evaluate the combined loan-to-value ratio, which usually cannot exceed 80-90% when adding both the first mortgage balance and the home equity loan together. VA cash-out refinances may permit up to 100% LTV for eligible borrowers .
Are the interest payments on these loans tax-deductible?
Interest on both cash-out refinances and home equity loans may be deductible if the funds are used to buy, build, or substantially improve the home securing the loan, subject to the overall mortgage interest deduction limit of $750,000 in total mortgage debt (for loans originated after December 15, 2017) . Consult a tax professional for guidance on your specific situation.
Which option has lower closing costs?
Home equity loans generally have lower total closing costs because the fees are calculated on a smaller loan amount. Some lenders also reduce or waive closing costs on home equity loans. However, cash-out refinance closing costs as a percentage of the loan amount may be comparable. The total dollar amount depends on the respective loan sizes.
Can I use either option for any purpose?
Generally yes. Both cash-out refinance proceeds and home equity loan funds can be used for home improvements, debt consolidation, education expenses, or other purposes. However, some loan programs may restrict the use of funds. For example, certain lenders may require that home equity loan proceeds be used for home improvements to qualify for specific promotional rates.
What happens if I sell my home with a home equity loan?
Under established real property law, liens are satisfied from sale proceeds in order of recorded priority. The first mortgage is paid before any subordinate liens, including home equity loans and HELOCs.. If the sale price does not cover both balances, you would need to bring funds to closing to cover the shortfall or negotiate a short sale with both lenders.
How does each option affect my debt-to-income ratio?
A cash-out refinance replaces your existing mortgage payment with a single new payment, which may be higher or lower depending on the new rate and term. A home equity loan adds an entirely new monthly payment on top of your existing mortgage payment. Lenders evaluate whether the resulting total monthly obligations remain within acceptable DTI limits, typically 43-50% depending on the loan program .

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