Cash-Out Refinancing vs Home Equity Loan: Which Option Is Right for You?
Comparing the pros and cons of different ways to access your home equity.
Jennifer Walsh
Mortgage & Home Equity Specialist
Homeowners with significant equity in their properties often face the decision of how best to access that wealth for important financial goals. Two popular options are cash-out refinancing and home equity loans (or lines of credit). Each approach has distinct advantages and drawbacks, making the optimal choice dependent on your specific financial situation and objectives.
Table of Contents
Understanding Cash-Out Refinancing
Cash-out refinancing involves replacing your existing mortgage with a new, larger loan, allowing you to pocket the difference in cash:
How Cash-Out Refinancing Works
Process Overview
- You apply for a new mortgage larger than your current loan balance
- The new loan pays off your existing mortgage
- You receive the difference in cash at closing
- You now have one new mortgage with new terms
Key Characteristics
- Replaces your existing mortgage entirely
- Can change loan term (15-year, 30-year, etc.)
- Can adjust interest rate type (fixed vs adjustable)
- Typically requires full underwriting process
Understanding Home Equity Loans
Home equity loans (and HELOCs) allow you to borrow against your home's equity while keeping your existing mortgage intact:
Home Equity Loans
- Fixed interest rate and monthly payments
- Lump-sum disbursement at closing
- Typically 5-30 year terms
- Interest-only or fully amortizing options
- Second lien position behind first mortgage
Home Equity Lines of Credit (HELOCs)
- Variable interest rate based on prime rate
- Revolving credit line you can draw from
- Draw period (typically 10 years) followed by repayment
- Payments vary based on amount drawn
- Second lien position behind first mortgage
Side-by-Side Comparison
Understanding the key differences between these options is crucial for making the right decision:
| Feature | Cash-Out Refinance | Home Equity Loan | HELOC |
|---|---|---|---|
| Interest Rate | Fixed (new rate) | Fixed | Variable |
| Loan Term | New term (15-30 years) | 5-30 years | 10-30 years |
| Closing Costs | High ($2,000-$5,000) | Moderate ($1,000-$3,000) | Low ($500-$2,000) |
| Monthly Payment | New payment | Additional payment | Variable based on draws |
| Credit Impact | New mortgage inquiry | Second lien | Second lien + revolving credit |
| Access to Funds | Lump sum at closing | Lump sum at closing | Revolving line of credit |
| Rate Lock | Yes | Yes | No (variable) |
When to Choose Each Option
The optimal choice depends on your specific financial goals and circumstances:
Choose Cash-Out Refinancing When:
- You can secure a significantly lower interest rate
- You want to change your loan term (shorten or extend)
- You prefer a single monthly payment
- You're consolidating high-interest debt
- You plan to stay in your home long-term
- You want to eliminate private mortgage insurance (PMI)
Choose Home Equity Loan When:
- You want to keep your existing favorable rate
- You need a predictable, fixed payment
- You're making home improvements
- You want to minimize closing costs
- You're planning a shorter-term borrowing need
- You prefer to keep your original mortgage intact
Choose HELOC When:
- You need flexible access to funds over time
- You're planning ongoing projects or expenses
- You want to minimize upfront costs
- You're comfortable with variable rates
- You have irregular income or cash flow needs
- You're using funds for investment purposes
Cost Considerations
Understanding all costs associated with each option is essential for accurate comparison:
Typical Costs Comparison
Cash-Out Refinance
- Origination fee: 0.5-1.0% of loan amount
- Appraisal: $300-$700
- Title insurance: $500-$2,000
- Credit report: $15-$50
- Recording fees: $100-$300
- Total: 2-5% of loan amount
Home Equity Loan
- Origination fee: 0-2.0% of loan amount
- Appraisal: $300-$700
- Title insurance: $200-$1,000
- Credit report: $15-$50
- Recording fees: $100-$300
- Total: 1-3% of loan amount
HELOC
- Origination fee: 0-1.0% of credit line
- Appraisal: $300-$700
- Title insurance: $200-$1,000
- Annual fees: $0-$200
- Recording fees: $100-$300
- Total: 0.5-2% of credit line
Tax Implications
The tax deductibility of interest varies by loan type and usage:
Interest Deductibility Rules
Cash-Out Refinance
Interest is deductible if proceeds are used for home improvements. If used for other purposes, deductibility may be limited or eliminated under current tax law.
Home Equity Loan
Under the Tax Cuts and Jobs Act, interest is only deductible if proceeds are used to buy, build, or substantially improve the home that secures the loan.
HELOC
Same rules as home equity loans - interest is deductible only if used for home-related improvements, purchases, or construction.
Note: Consult with a tax professional for advice specific to your situation, as tax laws are complex and subject to change.
Eligibility Requirements
Qualification criteria differ between these financing options:
Cash-Out Refinance Requirements
- Credit score: Typically 620+ (740+ for best rates)
- Loan-to-value ratio: Usually max 80-90%
- Debt-to-income ratio: Generally 43% or less
- Stable employment and income documentation
- Sufficient home equity (20%+ preferred)
- Property appraisal and inspection
Home Equity Loan/HELOC Requirements
- Credit score: Typically 660+ (680+ preferred)
- Loan-to-value ratio: Usually max 80-85%
- Debt-to-income ratio: Generally 43% or less
- Existing first mortgage in good standing
- Sufficient home equity (15-20%+ preferred)
- Property appraisal (sometimes automated)
Making the Right Decision
Several factors should guide your decision-making process:
Decision-Making Framework
Financial Considerations
- Compare total costs including closing fees
- Calculate break-even points for each option
- Evaluate interest rate advantages
- Consider your timeline for using funds
- Assess impact on monthly cash flow
Personal Factors
- Your risk tolerance for variable rates
- Length of time you plan to stay in home
- Your need for flexible vs. fixed access
- Current satisfaction with existing mortgage
- Future financial goals and plans
Using Calculators to Compare Options
Our mortgage calculators can help you model different scenarios and make informed decisions:
Refinance Calculator
Compare your current mortgage with potential cash-out refinance scenarios.
Try Our Refinance CalculatorPayment Calculator
Model different loan amounts and terms to understand payment impacts.
Try Our Payment CalculatorAffordability Calculator
Determine how much you can comfortably borrow based on your finances.
Try Our Affordability CalculatorCommon Scenarios and Recommendations
Different financial situations call for different approaches:
Scenario-Based Recommendations
Debt Consolidation
Cash-out refinance is typically best for consolidating high-interest debt, especially if you can secure a significantly lower rate than your existing mortgage.
Home Improvements
Home equity loan or HELOC often makes sense for home improvements, as interest may be tax-deductible and you can avoid refinancing costs.
Emergency Fund Access
HELOC provides the most flexibility for emergency access to funds, allowing you to draw only what you need when you need it.
Investment Opportunities
HELOC can be advantageous for investment purposes due to interest deductibility (consult tax advisor) and flexible draw periods.
Conclusion
Both cash-out refinancing and home equity financing offer valuable ways to access your home's equity, but the optimal choice depends on your specific financial situation, goals, and timeline. Cash-out refinancing makes sense when you can secure a significantly better rate or want to consolidate debt, while home equity loans and HELOCs provide more targeted access to funds with lower upfront costs.
Regardless of which option you choose, carefully consider all costs, tax implications, and your long-term financial strategy. Working with qualified professionals and using our mortgage calculators to model different scenarios will help you make the most informed decision for your unique circumstances.
Compare Your Options
Use our mortgage calculators to model different scenarios and determine which option provides the best value for your specific situation.
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