A home equity loan is useful if your only goal is drawing on your equity for a sizable planned expense. Since it's a separate loan from your existing mortgage, you’ll keep your current mortgage rate intact.
With a cash-out refinance, you replace your entire existing mortgage with a new, larger loan and pocket the difference in cash. A cash-out refinance serves a dual purpose by letting you potentially access a lower mortgage rate while also borrowing against your equity.
Keep reading to learn how a home equity loan vs. refinance works, and the pros and cons of each, and how to decide which one is the better choice for you.
How does a home equity loan work compared to a cash-out refinance?
A home equity loan is a popular financing option for homeowners who want to use their equity toward another lump-sum expense. According to the Mortgage Bankers Association, lenders anticipate an 4.1% increase in outstanding home equity loan debt in 2026.[2]
Home equity loans are a second mortgage that often come with fixed rates and lower closing costs compared to a cash-out refinance.
Your original mortgage loan and its monthly payment remains as-is. The home equity loan acts as a second lien on the home that you’ll pay separately each month.
You won’t be able to borrow 100% of your equity. Typically, you can access up to 80% to 85% of your equity stake, depending on your lender and your borrower qualifications.
Repayment terms vary, but terms up to 30 years are available. After closing, you’ll get a one-time payout that can go toward your financing goals. This might be to consolidate high-interest debt, pay for your child’s college education, or for an addition to your existing home.
| Home equity loan | Cash-out refinance | |
|---|---|---|
| Impact on current mortgage rate | None | Replaces rate |
| Total loans you’ll have | Two | One |
| Rates | Typically higher, fixed rates | Lower adjustable or fixed rates |
| Cost | Lower closing costs | Higher closing costs |
| Commonly used for | Large, one-time expense | Large expense, or to change mortgage rate/term |
A cash-out refinance loan, on the other hand, replaces your original mortgage loan, rate, and terms. The new refinance loan includes the old loan’s outstanding balance, plus the cash-out equity amount.
If your home is worth $500,000 and you owe $200,000 on your mortgage, your equity is $300,000. Assuming the lender caps the loan to no more than 80% of your equity, you’re left with a $400,000 maximum borrowing limit.
But remember that only half of that is your cash-out portion since you still owe $200,000 on the original loan. Interest rates can be either fixed or adjustable, and the process incurs similar closing costs (2% to 5%) as a conventional mortgage.
Like the home equity loan, the cash-out equity is funded in one lump sum upfront. Since cash-out refinances are typically larger than home equity loans, borrowers usually choose a full 30-year term. This long-term exposure with reduced equity can put you at greater risk of becoming underwater, if home value trends plummet.
How to decide if you need a home equity loan or refinance
If you're on the fence about whether to choose a home equity loan versus a cash-out refinance, here are some considerations to weigh. There's no one-size-fits-all answer. What works for someone with a 3% mortgage rate won't make sense for someone paying 7%. Let's break down the key factors that should drive your decision.
Your current mortgage rate
Looking at your existing mortgage rate can help you immediately rule out a cash-out refinance. Cash-out refinancing replaces your interest rate based on the current market.
Let’s say you lucked out with a fixed mortgage rate at 3% during the pandemic.[3] If you did a cash-out refinance today, you’d pay a higher rate on not just the cash-out portion of the loan, but on your outstanding mortgage amount too.
As of this writing, Federal Reserve Economic Data (FRED) reports that the average 30-year fixed-rate mortgage in the U.S. is 6.11%.[4]
“I can tell you that this current [rate] market is not gold,” says Bernie Frascarelli, executive loan offer at Best Interest Financial. “We’re not going to see a market decrease—we might see a 5.99% or 5.75%. Some people are expecting 4.99%, but I don’t see that happening.”
If you want your equity while preserving your existing mortgage rate, a home equity loan is the better fit.
Your borrowing goals
Think about why you’re taking out a loan. Are you hoping to borrow a relatively small amount for a one-off expense? Perhaps you’d also like a financing option with a simpler approval process. If so, a home equity loan can check off both boxes while limiting high interest rates to a smaller debt.
However, if your goal is changing the rate or term on your current mortgage—and borrowing your home equity in the process—a cash-out refinance might make more sense. It’s also the winning option if a simpler repayment experience is a high priority.
Your timeline with the house
Beyond interest rates, closing costs are another consideration. Generally, you’ll pay more closing costs on a cash-out refinance. Assume your home appraised for $500,000 and your refinance loan is $400,000 at 6% for 30 years. Your total estimated closing costs, including origination, is nearly $10,000.
You’ll need to ask your loan officer what your break-even point is in order to not end up losing money. If you move out of the house too soon before you can realize the full savings from refinancing, you could end up being out thousands of dollars from the closing costs you paid.
Pros and cons of home equity loans
Pros
- One-time, upfront funding
- Typically fixed rates
- Lower closing costs
- Paid interest might be tax deductible
Cons
- Rates are generally higher
- Creates a second lien on home
- Two mortgage payments
Pros and cons of cash-out refinancing
Pros
- Access to liquid cash flow
- One mortgage payment
- Unlocks new rates in low-rate markets
- Can offer tax benefits for paid mortgage interest
- Can change loan term
Cons
- Larger loan balance due to cash-out portion
- Shrinks your home equity
- High closing costs.
- Might pay more over a 30-year term
Does a home equity loan or a refinance cost more?
Many variables influence the costs associated with a home equity loan versus a cash-out refinance. Ultimately, it comes down to the loan amount, your rate, and how long you intend on keeping the loan.
A home equity loan might be a cheaper option if, for example, you’re borrowing a relatively small loan amount and your lender waived the closing costs. In this case, it might be the cheaper option if you plan on repaying it quickly.
If you’re borrowing a large amount and plan on keeping the loan long enough to offset the closing costs, a cash-out refinance might make sense if you locked in a rate that’s lower than your existing mortgage loan.
Meet with a loan officer before you decide
Borrowing against your equity can be a valuable financing option, if you need a substantial influx of cash. But finding the right strategy to do so is complicated and nuanced and highly dependent on your personal circumstances.
Best Interest Financial can walk you through various home equity vs. refinancing scenarios so you’re fully comfortable in your financing decision. We support every step of the process, from helping you compare your options to closing. Get started with a quick quote from Best Interest and a loan officer will contact you shortly.
FAQ about home equity loans and refinancing
Can I borrow from my home equity without refinancing?
Yes, a home equity loan or a home equity line of credit (HELOC) lets you pull cash from the equity you’ve built without impacting your existing mortgage. Home equity financing options are considered second mortgages and are completely separate from your original home loan.[1]
What is the cheapest way to get equity out of your house?
There isn’t one financing solution that’s the cheapest option for every borrower or situation. Getting equity out of your home in the most affordable way involves different variables. For example, a home equity loan might offer lower closing costs, but it typically has a slightly higher rate, compared to a cash-out refinance. The best way to know what the cheapest option is for you is to meet with a loan officer.
What is the downside of a home equity loan?
Some disadvantages of a home equity loan include closing costs and adding a second mortgage payment. Like your primary mortgage loan, a home equity loan uses your home as collateral. If you can’t make your payments, you’re at greater risk of foreclosure.
What will disqualify you from a home equity loan or refinance?
One reason you might be disqualified from a home equity loan or cash-out refinance is if your equity isn’t high enough. Other factors, like having insufficient income, a high debt-to-income ratio, or poor credit are other red flags that lenders watch for.
Disclaimer: The information provided in this article is for informational and educational purposes only. It is not intended as legal, financial, investment, or tax advice, and should not be relied upon as such. Mortgage rates, terms, products, and eligibility requirements are subject to change without notice and vary based on individual circumstances, credit profile, property type, loan amount, and other factors. All loans are subject to credit approval. This content does not constitute a commitment to lend or an offer of specific loan terms. For personalized mortgage advice and to discuss loan products that may be suitable for your situation, please contact one of our licensed loan officers.