Home Equity Loan Vs. Refinance: Pros And Cons To Consider

There are a few ways you can tap into your home equity, each with its own advantages and disadvantages. The two most common ways to access your home equity are cash-out refinances and home equity loans.

But these options have some key differences you’ll need to understand to determine which one is best for you. So, in the battle of home equity loan vs. refinance, which option wins? In this article, we’re breaking down all the pros and cons so that you can make the best decision for your specific situation.

Home Equity Loan Overview

A home equity loan allows homeowners to borrow against their home equity in the form of a second mortgage. You can think of this similarly to your first mortgage, as this option uses your home as collateral to secure the loan.

The amount you can borrow with a home equity loan is equal to a certain percentage of your home equity – the difference between your home’s value and your mortgage balance. Lenders use a loan-to-value ratio (LTV) to determine precisely how much you can borrow. With a home equity loan, your cash comes in the form of a lump sum payment, which is then repaid to the lender in fixed installments over a predetermined period of time.

Cash-Out Refinance Overview

A cash-out refinance presents an opportunity for homeowners to access the equity in their home by refinancing their existing loan into a new mortgage with a higher loan amount, allowing them to receive the difference in a lump sum of cash.

The “cash out” amount you get depends on your home’s equity and value, which means your lender will require an appraisal to determine the home’s current value at the time of the refinance. The more you’ve paid down on your house, the more equity you have accrued and therefore the more cash you can borrow. But the same goes for home prices in your area – if home prices have gone up, it’s likely your home equity has also gone up as well.

Want to know how much your home is worth? You can easily add your home as an asset and track your equity using the Net Worth feature within Rocket Money^SM.

What Are The Similarities Between A Cash-Out Refinance And A Home Equity Loan?

Cash-out refinances and home equity loans have a lot of similarities. Both options allow homeowners to convert their home’s equity into cash that can be used for just about anything, such as funding, consolidating debt, paying off credit cards and saving for your child’s college tuition.

Most homeowners like these types of loans because they tend to offer lower interest rates than other types of financing, like personal loans and credit cards. But with both loan options, you’ll need to keep some of your equity in the home after the transaction is complete. The amount of equity that needs to stay in the home is typically between 10% – 20% for a property that is your primary residence.

Both cash-out refinances and home equity loans come with fixed and adjustable-rate options and end in borrowers receiving a lump sum payment. This means you’ll get all of the proceeds from the loan at one time.

What Are The Differences Between A Cash-Out Refinance And A Home Equity Loan?

Where a home equity loan is a second mortgage, a cash-out refinance replaces your current mortgage. A home equity loan requires a new monthly payment on top of your existing mortgage payment, while a refinance creates an opportunity to negotiate new loan terms such as a lower interest rate, a smaller monthly payment or a new type of mortgage loan.

In many cases, you could end up paying a higher interest rate on a home equity loan because lenders perceive it to be a higher risk than a refinance.

Home Equity Loan Pros And Cons

For the right borrower at the right time, home equity loans can be a powerful financial tool – freeing up funds for just about any pressing project. But it’s important to understand all the pros and cons associated with this option to determine if it’s right for you.

Pros

• Won’t affect your primary mortgage
• Offered with fixed interest rates
• Lower interest rates than a personal loan or credit card
• Tax-deductible interest for some borrowers

Cons

• Second mortgage means two mortgage payments
• Higher risk of foreclosure due to second lien on the property
• Stricter qualification requirements
• Requires a significant amount of equity

Cash-Out Refinance Pros And Cons

If you’d prefer to stick with one mortgage payment, a cash-out refinance might be a better option. But before submitting an application, review the following benefits and drawbacks to ensure you’re choosing the best loan option for your specific situation.

Pros

• Only one monthly mortgage payment
• Lower credit score requirements
• Lower lender risk means potentially lower interest rate
• Fixed or adjustable-rate loan options

Cons

• Higher mortgage balance means adding years to your loan term
• Risk of foreclosure
• Longer underwriting process
• Higher closing costs

Is A Refinance Or A Home Equity Loan Right For You?

A cash-out refinance might be the better choice if you’d prefer to deal with one mortgage payment instead of two. In other words, if you want to simplify your loan payments, a cash-out refinance is smarter because you won’t have to worry about balancing multiple due dates and repayment terms. It's possible that a cash-out refinance could also offer lower interest rates, which would save you more money in interest in the long run.

On the other hand, if interest rates have risen since you bought your house, you may want to avoid changing your loan terms. In that vein, home equity loans can be a smart choice if you still want to receive a lump sum payment without having to make changes to your primary mortgage. Or, if you’d rather have access to cash over time, a home equity line of credit (HELOC) is another option.

Cash-Out Refinance Vs. Home Equity Loan FAQs

Can I tap into my home equity without refinancing?

Yes, there are several different options to access your home's equity without refinancing. Getting a home equity loan or a home equity line of credit are two such options. With both a home equity loan and a HELOC, you can use some of your equity without having to replace your existing mortgage.

What are the potential downsides to using a cash-out refinance?

One of the biggest possible downsides is that you will usually end up with a higher mortgage balance and/or a longer term. This would mean that you're on the hook for additional interest payments over the length of your new loan. Additionally, if interest rates have gone up since you initially took out your mortgage, your monthly payment may be significantly higher than your original payment amount.

How are home equity loans and refinances different?

Yes, a home equity loan and a refinance are two different types of loan products that allow borrowers to access their home's equity. Both a home equity loan and a refinance come with their own pros and cons, so make sure that you understand the differences. That will help you make the right choice for your specific situation.

Is a home equity line of credit the same as a home equity loan?

Unlike a home equity loan, HELOCs have variable interest rates, which means the initial rate on a HELOC may be lower than what you’d get with a home equity loan or cash-out refi, but the rate will ultimately vary as market interest rates change. The other main difference is the way the funds are disbursed. Instead of a lump sum payment at closing, you can withdraw funds as needed up to a certain credit limit.

The Bottom Line

Both cash-out refinances and home equity loans allow you to potentially tap into your home equity so you can use the cash for just about any purpose. Regardless of which option you choose, taking on additional debt is a big decision – especially when it’s connected to your home – so it’s important to weigh your options carefully.

Consider consulting with a financial expert if you need help deciding between a cash-out refinance and a home equity loan. If you’ve decided a cash-out refi is right for you, get started on the refinance process today with Rocket Mortgage^®.