Americans are sitting on a lot of home equity, thanks to the hot housing market of the past few years. According to August data from financial services company CoreLogic, the average person paying back a mortgage in spring 2022 had $280,000 in home equity, a $125,000 increase over the past five years.
You don't have to sell your home to take advantage of that increase in value. Instead, cash-out refinances and home equity loans are both ways to borrow money based on the equity you have accumulated. If you're considering tapping your equity to cover some major expenses, it's important to understand the key differences between cash-out refinances and home equity loans.
What is a cash-out refinance?
A cash-out refinance replaces your existing mortgage with a new one for a higher amount. For example, let's say you still owe $75,000 on a current mortgage, which has a 6% interest rate, and the home is worth $400,000. You want to remodel the kitchen and bathroom and get a $175,000 cash-out refi. The loan pays off the existing mortgage; going forward, you have a new $175,000 mortgage. You have effectively cashed out $100,000 of the home's equity, and you'll be paying back that loan with an updated interest rate and a new term.
It's important to note that most lenders will allow you to borrow up to 80% of the home's total value. So, in this case, you technically could qualify for a cash-out refinance amount of up to $320,000.
- One consolidated loan to manage and pay back
- Ability to qualify with a lower credit score
- Interest rates are lower than personal loans and credit cards
- Potential tax benefits (you can deduct interest if you're using the loan to improve your home)
- Comes with a new set of closing costs (and hefty taxes in some states)
- Requires a long time to close -- an average of 49 days, according to ICE Mortgage Technology
- Rising rate environment could result in a more expensive mortgage
- Risk of foreclosure if you don't pay refi back on time
Who might benefit from a cash-out refinance?
A homeowner with a fair to good credit score and an existing mortgage with a high interest rate can benefit from a cash-out refi. Additionally, you'll want to be in the home long enough to justify your closing costs.
What is a home equity loan?
A home equity loan is a second mortgage. Unlike a cash-out refinance that replaces an existing mortgage, a home equity loan is a second loan. So, you'll keep paying off the original mortgage and have another loan to manage, too. For example, if you have a $75,000 outstanding balance on your current mortgage and the home is worth $400,000, you have $325,000 of equity. Most lenders will allow you to have up to 85% of the equity in your home, including that first mortgage. So, in this case, the total mortgage debt may be up to $340,000. Because you have an existing mortgage of $75,000, you might be able to qualify for a home equity loan up to $265,000.
- Some lenders can close much faster -- between two and four weeks
- Some lenders don't charge additional closing costs (although, you'll still likely pay for an appraisal, title services and other fees)
- Lower rates than personal loans and credit cards
- Potential tax benefits (can deduct interest if you're using the loan to improve your home)
- Often requires a higher credit score for approval
- Higher interest rates than refinances
- Risk of foreclosure if you don't make on-time payments
- Two separate mortgages to manage
Who might be a good candidate for a home equity loan?
A homeowner who already has a low interest rate on their existing mortgage who needs additional cash for major expenses.
Comparing the costs of a cash-out refinance with a home equity loan
Rates on cash-out refinances tend to be lower than home equity loans. The rates in this table reflect the most recent average rates for both products from Bankrate, CNET's sister site. It's important to note that while the interest rate is lower, the amount financed may be much higher because a cash-out refinance will pay off the first mortgage. In this scenario, the home equity loan is a much better option.
Cash-out refinance vs. home equity loan
||15-year cash-out refinance||15-year home equity loan|
|Monthly principal and interest payment||$1,520||$920|
|Total lifetime cost of loan||$277,279||$167,668|
Closing costs, although hypothetical in this example, vary based on a variety of factors including location, lender and the loan's size. If you're comparing a cash-out refinance with a home equity loan, it's important to compare multiple lenders to understand the upfront expenses.
Cash-out refinance vs. home equity loan: Which one is right for you?
There isn't a one-size-fits-all answer when comparing a cash-out refinance with a home equity loan. Here are a few key factors to consider.
The interest rate on your current mortgage: Generally, refinancing only makes sense if you can lower your interest rate. So, if you're paying 7% on your current mortgage, and you can find a cash-out refinance option for 6%, this might be a smart move. However, if you refinanced during the pandemic boom of refinancing and managed to lock in a 3% interest rate, a cash-out refinance likely doesn't make sense now.
How quickly you need the cash: Home equity loans tend to close faster than refinances. So, if you're looking to start a project soon, you may want to look for lenders who can close and distribute your funds on an accelerated timeline.
Your credit score: Because a lender who reviews your cash-out refinance application has first dibs on your home in the event of a default, you'll likely be approved with a lower credit score. Home equity lenders are second in line -- hence the phrase "second mortgage" -- so you'll typically need a higher credit score for these loans.
The bottom line
Cash-out refinances and home equity loans are both options to access cash based on the amount of equity you've accumulated as a homeowner. While each can help you receive the cash you need to help deal with big expenses such as remodeling your home, paying off high-interest credit cards or covering a child's college education, there are unique differences between the two. Most importantly, they share a common rule you should keep in mind before taking on more debt: If you don't pay them back, you can lose your home.
What is a no-cash-out refinance?
A no-cash-out refinance is exactly what it sounds like: You won't be borrowing any additional money. These are often called rate-and-term refinances because the borrower opts to adjust their rate and term to lower their monthly payments and/or accelerate the time to pay off the loan.
How does a cash-out refinance work?
A cash-out refinance is a new loan with a bigger amount than your existing mortgage. The funds will pay off your first mortgage, and you'll receive the additional money to use however you choose. It's a brand-new loan with a new interest rate and new terms.
What can you use a cash-out refinance or a home equity loan for?
Just about anything: There aren't restrictions about what you can do with cash you borrow via cash-out refinance or home equity loan. The best use of the funds from a cash-out refinance or a home equity loan is to make a substantial improvement to your home -- taking out equity to build more equity by remodeling the kitchen or installing a new bathroom, for example. These also qualify for tax deductions.