When homeowners need access to cash, two of the most popular borrowing options are a home equity loan and a cash-out refinance. Both allow you to tap into your home’s equity, but they work differently and can have significantly different costs depending on your financial situation.
Understanding the differences between these financing options can help you determine which one may save you more money over the long term.
What Is a Home Equity Loan?
A home equity loan allows you to borrow against the equity you’ve built in your home while keeping your existing mortgage intact.
You’ll receive a lump sum of money and repay it through fixed monthly payments over a predetermined term.
Key Features
- Fixed interest rate
- Fixed monthly payments
- Lump-sum disbursement
- Separate loan from your primary mortgage
- Predictable repayment schedule
Because the loan is secured by your property, interest rates are often lower than those of personal loans or credit cards.
What Is a Cash-Out Refinance?
A cash-out refinance replaces your current mortgage with a new, larger mortgage.
The new loan pays off your existing mortgage, and you receive the difference in cash.
Key Features
- Replaces your current mortgage
- Creates a new mortgage term
- May offer fixed or adjustable rates
- Provides a lump-sum payout
- Results in one monthly mortgage payment
This option effectively resets your mortgage and creates a brand-new loan agreement.
How Each Option Works
Home Equity Loan Example
Suppose:
- Home value: $500,000
- Current mortgage balance: $250,000
- Available equity: $250,000
You take out a $75,000 home equity loan.
Result:
- Existing mortgage remains unchanged
- New home equity loan added
- Two monthly payments
Cash-Out Refinance Example
Using the same property:
- Home value: $500,000
- Mortgage balance: $250,000
- Cash needed: $75,000
You refinance into a new mortgage for $325,000.
Result:
- Original mortgage is replaced
- One new mortgage payment
- $75,000 received at closing
Which Option Usually Has Lower Interest Rates?
Historically, cash-out refinances often offer lower interest rates than home equity loans because they become the primary mortgage.
However, interest rate comparisons depend heavily on market conditions.
Cash-Out Refinance May Save Money If:
- Current mortgage rates are lower than your existing rate
- You can secure a favorable refinance rate
- You plan to stay in the home long enough to recover closing costs
Home Equity Loan May Save Money If:
- Your current mortgage has a low interest rate
- Current market rates are significantly higher than your existing mortgage rate
- You only need a moderate amount of cash
In today’s higher-rate environment, many homeowners prefer preserving their low-rate mortgage and adding a smaller home equity loan instead.
Comparing Monthly Payments
Home Equity Loan
Pros:
- Keeps your original mortgage unchanged
- Fixed repayment schedule
- Easier to estimate future costs
Cons:
- Two monthly payments
- Potentially higher interest rate than a primary mortgage
Cash-Out Refinance
Pros:
- One monthly payment
- Potentially lower interest rate
- Simplified debt structure
Cons:
- Mortgage term may restart
- Total interest paid over time may increase
A lower monthly payment doesn’t always mean you’ll spend less overall.
Closing Costs Comparison
One major factor many borrowers overlook is closing costs.
Home Equity Loan Costs
Typically include:
- Appraisal fees
- Origination fees
- Recording fees
- Title-related expenses
Closing costs are often lower than those of a full refinance.
Cash-Out Refinance Costs
May include:
- Loan origination fees
- Appraisal fees
- Title insurance
- Closing costs similar to a traditional mortgage refinance
Because you’re replacing an entire mortgage, refinancing often involves higher upfront expenses.
When a Home Equity Loan Can Save More Money
A home equity loan may be the better financial choice if:
- You already have a low mortgage rate
- You only need a limited amount of cash
- You want to avoid restarting your mortgage term
- You plan to repay the borrowed funds relatively quickly
Example
If your existing mortgage rate is 3.0% and current refinance rates are 6.5%, replacing your entire mortgage could significantly increase borrowing costs.
In this scenario, keeping your original mortgage and adding a home equity loan may save thousands of dollars over time.
When a Cash-Out Refinance Can Save More Money
A cash-out refinance may provide greater savings when:
- Current mortgage rates are equal to or lower than your existing rate
- You need a substantial amount of cash
- You want to consolidate multiple debts
- You prefer a single monthly payment
The larger the amount borrowed, the more valuable a lower interest rate can become.
Risks of Both Options
Regardless of which option you choose, both involve borrowing against your home.
Potential risks include:
- Foreclosure if payments are missed
- Reduced home equity
- Increased debt obligations
- Higher total interest costs over time
Borrow only what you need and ensure payments fit comfortably within your budget.
Questions to Ask Before Choosing
Before making a decision, consider:
- What is my current mortgage interest rate?
- How much cash do I need?
- How long do I plan to stay in the home?
- Can I comfortably manage two payments?
- What are the total closing costs?
- Which option results in lower lifetime borrowing costs?
Comparing these factors can reveal which solution provides the greatest savings.
Bottom Line
Whether a home equity loan or cash-out refinance saves you more money depends largely on your existing mortgage rate, borrowing needs and long-term financial goals.
A home equity loan often makes more sense when you already have a low-rate mortgage and want to preserve it. A cash-out refinance may provide greater savings if you can secure a favorable new mortgage rate and benefit from combining debt into a single loan.
Before committing to either option, compare rates, fees, repayment terms and total lifetime costs from multiple lenders. The cheapest monthly payment isn’t always the most affordable choice in the long run.
Leave a Reply