Cash-out refinance vs. home equity loans: Which is best in today's lower-rate market?

Home equity is at historic highs. And if you’ve been faithfully paying your mortgage, you’ve likely built up quite a bit of it yourself. According to the Federal Reserve, American homeowners now hold a staggering $48.2 trillion in home equity as of 2024. Could it be time to put some of yours to work?

Two options for accessing the cash in your home include a cash-out refinance or home equity loans — including HELOCs — which you can use for home renovations, to consolidate debt or pay for education expenses.

But in today’s high-rate environment, Matt Weaver, a loan originator at Florida-based CrossCountry Mortgage, urges caution: “The only people who should consider tapping into their equity are those who have a better use for the money. A ‘better use’ could be funding home renovations instead of buying a more expensive house, or consolidating $70,000 in high-interest credit card debt that would otherwise take years to pay off.”

With that guidance in mind, we explore how cash-out refinancing and home equity loans work, including factors to consider and financing alternatives, to find the best fit for your financial situation and borrowing needs.

What is a cash-out refinance?

A cash-out refinance is a type of loan that replaces your existing mortgage with a new, bigger mortgage, letting you “cash out” the difference to your bank account. The new loan pays off your current mortgage, and you receive the extra funds — less closing costs — when you close on the loan.

Cash-out refinances typically offer 15- or 30-year terms with fixed or adjustable rates. Unlike home equity loans, which add a second payment to your budget, you end up with one new mortgage payment that replaces your old loan’s payment.

To qualify for a cash-out refinance, most lenders require:

• A credit score of 620 or higher (680+ get lower rates)

• Up to 20% equity remaining after the refinance

• A debt-to-income ratio below 43%

• Proof of stable income

• Good payment history

Dig deeper: Cash-out refinance explained: How it works and when it can make sense

Benefits of a cash-out refinance

A cash-out refinance offers certain advantages that might make it worthwhile, particularly if the following are true for you:

• You need the money to save money. Examples might be adding a third bedroom to avoid an expensive and stressful move to a larger home, or consolidating $70,000 in credit card debt at 20% APR into a 7% mortgage loan — turning an $1,800 monthly credit card payment into around $500 in added mortgage cost, and saving you $1,300 each month.

• You’re borrowing a larger amount. Since closing costs for a cash-out refinance can be substantial, this option usually makes more financial sense when borrowing large sums rather than smaller amounts.

• You can secure a lower interest rate. If today’s mortgage rates are lower than what you’re currently paying, refinancing lets you apply that lower rate to both your existing loan balance and any additional money you borrow.

• You need a longer repayment period. Cash-out refinances offer terms up to 30 years, spreading your payments over a longer period — though you’ll pay more in total interest over time than with a 15-year term.

• Your lender waives future refinancing costs. According to Weaver, some lenders will waive lender fees if you refinance today and then refinance later when rates drop. This can help reduce the worry about refinancing too soon or missing out on better rates down the road.

Dig deeper: Should you use your home equity to pay off high-interest debt?

Drawbacks of a cash-out refinance

Cash-out refinances can have several drawbacks, even when you’re able to secure a lower interest rate than your current mortgage, including:

• Higher closing costs. You’ll pay significant closing costs, typically 2% to 5% of the loan amount. On a $200,000 loan, that’s $4,000 to $10,000, making them expensive compared to home equity loans or HELOCs, which often have minimal or no closing costs.

• Reduced equity. Taking cash out reduces your ownership stake in your home. This could limit your financial options down the road — for example, if you need to sell when the market is down or want to borrow against your equity again in the future.

• Resets your loan term. Taking a new 30-year mortgage means starting over with your amortization schedule, potentially paying more interest over time compared to keeping your existing mortgage.

• Complex refinancing process. The application and approval process for a cash-out refinance is typically longer and more involved than for a home equity loan or HELOC.

What are home equity loans?

A home equity loan (HELoan) is a second mortgage that lets you borrow against your home’s equity while keeping your original mortgage intact. Unlike a cash-out refinance, you get a separate loan with fixed rates, terms of 5 to 20 years and often lower or no closing costs.

A home equity line of credit (HELOC) is a close cousin of the HELoan. It features a variable rate and functions like a credit card, letting you borrow and repay repeatedly during a 5 to 10 year draw period. HELOCs also come with low or no closing cost options.

“While I advised against HELOCs during the past three years because of rising rates, they’re now worth considering for short-term borrowing — typically 36 to 60 months,” says Weaver. “With variable rather than fixed rates, HELOCs could become more attractive as rates drop.”

To qualify for a home equity loan or HELOC, most lenders require:

• Credit score of 620 or higher

• At least 15% to 20% equity in your home

• Debt-to-income ratio below 43%

• Stable income history

• Good payment history

Benefits of home equity loans and HELOCs

For homeowners who want to keep their existing mortgage rate while still tapping into their equity, home equity loans and HELOCs offer these benefits:

• Keep your existing mortgage rate. If you locked in a historically low rate on your first mortgage in recent years, a home equity loan lets you keep that rate while borrowing additional funds at today’s rates.

• Lower closing costs. Home equity loans and HELOCs typically have significantly lower closing costs than cash-out refinances — often less than $500 — making them more cost-effective for smaller loan amounts.

• Faster closing process. The application process usually takes just two to four weeks, compared to 30 to 45 days for a refinance. There’s generally less paperwork too, since you’re not replacing your entire mortgage.

• Take advantage of falling rates with HELOCs. Because HELOCs offer variable rates, your payments could decrease automatically as interest rates drop in a falling interest rate environment.

Drawbacks of home equity loans and HELOCs

While home equity products can be cheaper than cash-out refi, stay mindful of these drawbacks:

• Higher interest rates. As a type of second mortgage, rates for home equity products can be 1% to 2% percentage points higher than first mortgages or cash-out refinances, since they’re riskier for lenders.

• Two monthly payments. You’ll need to manage two separate payments each month: your original monthly mortgage payment and the home equity loan payment. While it can help you track the extra debt, it also means two different due dates and systems to manage.

• Reduced equity. Taking out a home equity loan immediately decreases your ownership stake in your home. Each dollar you borrow is a dollar less you have in equity, which could limit your options if you need to sell or borrow again in the future.

• Risk of foreclosure. Like cash-out refinancing, home equity loans use your home as collateral. Missing payments on either your first or second mortgage could put your home at risk of foreclosure.

Dig deeper: Fact vs. fiction: Top 8 common home equity myths — debunked

Cash-out refinance vs. home equity products: How to choose

When deciding between these loan options, ask yourself these questions:

1. Do you need the money now? If you want to have access to funds for peace of mind, a HELOC might be your best bet — you can open the line of credit but won’t pay anything until you use it.

2. How much equity do you need to access? Higher closing costs make cash-out refinancing a better fit for a larger amount of money, while home equity loans and HELOCs often make more sense for borrowing smaller amounts.

3. Do you want a longer loan term or interest savings? Cash-out refinances can stretch to 30 years for lower monthly payments. Home equity loans usually run 5 to 20 years, meaning potentially higher monthly payments, but less total interest.

4. Can you pay high closing costs? Cash-out refinances charge 2% to 5% of the loan in closing costs. Home equity loans have minimal or no closing costs, making them more affordable up front.

5. How long do you plan to stay in your home? You’ll typically need several years to recoup the higher closing costs of a cash-out refinance. For shorter time frames, the lower upfront costs of a home equity loan or HELOC might make more sense.

When a cash-out refinance might make sense

Cash-out refinancing could be your best option if most of the following are true:

• You need to access a large amount of equity (say, over $50,000)

• Current market rates are lower than your existing mortgage rate

• You plan to stay in your home long enough to recoup the closing costs

• You want the longest possible repayment term

• You’re looking to combine multiple debts into one payment

When a home equity loan might make sense

Consider a home equity loan or HELOC if most of the following are true:

• You need to access a smaller amount of equity

• You have a favorable rate on your existing mortgage

• You want to avoid high closing costs

• You prefer a faster closing process

• You want to maintain your original mortgage payoff date

Dig deeper: 5 ways to build equity in your home more quickly (and why it matters)

At a glance: Cash-out refinance vs. home equity loans

Alternatives to cash-out refinance and home equity loans

Consider these alternatives depending on your financial needs.

• Personal loans. With an unsecured loan, you can borrow money without using your home as collateral, protecting your property from foreclosure risk. Though rates are typically higher than home-secured loans, you may prefer keeping your housing and borrowing needs separate.

• 0% intro APR credit cards. A credit card offering a no-interest period can be useful for smaller expenses you can fully repay during the promotional period, usually 12 to 21 months. Otherwise, interest rates increase substantially after this promo period ends.

• Reverse mortgage. For homeowners ages 62 and older, this option converts home equity into payments with no monthly repayment required. The loan becomes due when you move, sell or die. However, reverse mortgages come with significant risks and costs.

• 401(k) loans. If you have a retirement account through your employer, you may be able to borrow up to 50% of your vested balance through a 401(k) loan. But if you leave your job, the full loan amount typically becomes due quickly, among other risks to consider.

• Government-backed renovation loans. Programs like the FHA 203(k) loan designed specifically for home improvements could be worth looking into if you’re using funds for qualifying renovations or repairs.

• Life insurance policy loans. If you have a permanent life insurance policy (like whole life or universal life), you may be able to borrow against its cash value, often at relatively low interest rates.

• Home sale and downsizing. If you’re living in more house than you need, selling and moving to a smaller home could give you immediate access to your equity without taking on more debt (or sinking more money into your current home).

Dig deeper: Top home renovations that can increase your property’s value — and quality of life

Other stories in our mortgages and home loans series

FAQs: Home equity, refinancing and protecting your money

Find answers to some of the most common questions about cash-out refinances and home equity products. Also, take a look at our growing library of personal finance guides that can help you save money, earn money and grow your wealth.

What’s the difference between a home equity loan and a cash-out refinance?

A home equity loan adds a second mortgage to your existing one, while a cash-out refinance replaces your current mortgage with a new, larger loan that provides extra cash from your home’s built-up equity.

How much equity do I need to refinance my mortgage?

Many lenders want to see that you’ve built at least 20% equity in your home before considering you for refinancing for the best rates with no private mortgage insurance. If you have good to excellent credit, some lenders and even mortgage types — like FHA and VA loans — will allow you to refinance with less equity. Learn more in our guide to timing your mortgage refinance.

Can a lender ask my age as part of the application process?

Yes, but a lender or broker can’t legally deny your application based on your age. Your date of birth is often included on an application as part of the usual personal and information a lender or creditor gathers, and while your age can be a consideration among other factors — such as your income and credit score — it can’t be considered alone to decline you a loan or credit. The only age requirement is that you must be at least 18 years old. Learn more in our guide to mortgage approval in retirement.

Will I lose equity in a cash-out refinance?

Yes. Say your home is worth $400,000 and you owe $200,000 — in this case, you have $200,000 in equity. A cash-out refinance for $250,000 would reduce your equity to $150,000 because you’ve borrowed an additional $50,000.

Should I get prequalified for a mortgage loan?

Prequalification could be a good first step in the mortgage process, providing you with an informal estimate of how much you may be able to borrow. Unlike mortgage preapproval, prequalification provides a quick way to evaluate your financial readiness to purchase a home without the need to complete a lengthy mortgage application or gather personal and financial documentation. Learn more about the difference between these two important homebuying tools in our guide to home loan preapproval and prequalification.

Do I need an appraisal for a home equity loan?

While many home equity loans require an appraisal to determine your home’s current value, if you’ve recently bought your home and have excellent credit, you might be able to find a lender that offers no-appraisal home equity loans. These loans use digital tools and hybrid models that assess your home’s features and recently sold homes in your neighborhood, among other factors, to determine your home’s value. Start with specialty digital lenders like Figure or LoanDepot. And learn how they work and what to expect in our guide to no-appraisal home loans.

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About our writer

Kat Aoki is a seasoned finance writer who’s written thousands of articles to empower people to better understand technology, fintech, banking, lending and investments. Her expertise has been featured on sites like Lifewire and Finder, with bylines at top technology brands in the U.S. and Australia. Kat strives to help consumers and business owners make informed decisions and choose the right financial products for their needs.

Article edited by Kelly Suzan Waggoner