You have $85,000 of equity in a $410,000 house. The roof needs replacing and you want to clear a $22,000 credit card balance. A cash-out refinance and a home equity loan can both put the money in your account. They are not interchangeable, and the cheaper option depends on numbers most ads ignore.
How Each Loan Actually Works
A cash-out refinance replaces your current first mortgage with a larger one. If you owe $250,000 and need $70,000, the new loan might be $320,000. The lender pays off the old mortgage, gives you the difference minus closing costs, and you make one payment on the full $320,000. The rate applies to every dollar of that new balance.
A home equity loan is a second mortgage. Your first mortgage stays untouched. You borrow $70,000 against your equity, receive a lump sum, and repay it on a separate schedule, usually at a fixed rate. You then make two payments: the original first mortgage and the new second mortgage. A HELOC is similar but works like a credit line with a variable rate, so a fixed home equity loan is the closer comparison here.
Cash-Out Refinance vs Home Equity Loan: The Rate Trap
This is where most comparisons go wrong. A home equity loan often has a higher rate than a cash-out refinance. That does not automatically make it more expensive. Look at the balance each rate applies to.
Say your first mortgage is $250,000 at 3.25% and you need $70,000. A cash-out refinance at 6.75% charges that rate on $320,000. The $250,000 you already owed gets repriced from 3.25% to 6.75%. The extra interest on that old balance alone is about $8,750 in the first year. A home equity loan at 8.5% charges the higher rate only on the $70,000 you need, roughly $1,225 more interest per year than borrowing that $70,000 at 6.75%. The second loan can look pricier and still cost less overall.
Flip the scenario. If your current mortgage is at 7.5% and a cash-out refinance lands at 6.5%, you lower the rate on the entire balance and pull cash at the same time. That can be a strong deal. The same loan can also cost more at one bank than another, so compare refinance rates by lender before you assume the first quote is the market.
Closing Costs Change the Math
A cash-out refinance usually costs 2% to 5% of the new loan amount. On $320,000, that is $6,400 to $16,000. The fees include appraisal, title insurance, lender fees, recording fees, and possibly points. No-cost refinances often come back as a higher rate.
A home equity loan typically costs 1% to 3% of the amount borrowed, and some lenders waive costs on smaller loans. On $70,000, that is $700 to $2,100. If a cash-out refinance saves $80 a month but costs $9,000 more upfront, you need more than nine years to break even. Many homeowners do not keep the same loan that long.
When a Cash-Out Refinance Makes More Sense
A cash-out refinance often wins when your current mortgage rate is high enough that refinancing lowers the cost on money you already owe. If you are paying 7.75% and can lock 6.5% on a larger loan, the rate drop can offset the closing costs and the cash you pull out.
It also fits when you need a large sum, usually more than $100,000. Second mortgages can have lower maximum loan amounts and tighter combined loan-to-value limits. If you need $150,000 for an addition, a cash-out refinance may be the only practical option. If the money is going into a kitchen or extra bedroom, run the project through the break-even math in this guide to cash-out refinance for home improvements before you touch your equity.
Debt consolidation can also favor a cash-out refinance, but only if the new rate beats the weighted average of the debts you are paying off. Moving $30,000 of credit card debt at 24% into a 6.5% mortgage lowers the interest rate, but it turns unsecured debt into debt secured by your house. Miss enough payments and the lender can foreclose. The lower payment is real; so is the risk.
When a Home Equity Loan Wins
If your first mortgage is at 3.25% or 4%, protecting that rate is usually the priority. A home equity loan lets you borrow against equity without disturbing a cheap first mortgage. You keep the low rate on the large balance and pay a higher rate only on the smaller second loan.
A fixed home equity loan also makes sense when:
- You need less than $100,000 and the closing costs on a full refinance would take years to recover.
- You want a fixed payment and a set payoff date, not a variable HELOC rate.
- You are close to paying off the first mortgage and do not want to reset it to 30 years.
- You can qualify for a second mortgage with a combined loan-to-value ratio that fits the lender’s limits.
Home equity loans are not free money. They are secured by the house, and the lender can foreclose if you default. A second mortgage also makes it harder to sell if the home value drops and the combined debt is close to the sale price.
Qualifying Differences That Can Decide It
Cash-out refinances go through full first-mortgage underwriting. Lenders check credit, income, debt-to-income ratio, reserves, and loan-to-value. Many cap cash-out refinances at 80% LTV, though some go to 85%. The appraisal matters because it sets the value used to calculate how much equity you can access.
Home equity lenders look at combined loan-to-value, which is the first mortgage plus the second divided by the home’s value. Some allow 85% or 90% combined LTV. The second lender also checks credit and debt-to-income ratio, including the new payment. A home equity loan can be easier to qualify for when you need a modest amount and the first mortgage is already low.
If you are self-employed, have variable income, or have a recent credit event, documentation and waiting periods can affect either loan. Cash-out refinances tend to have stricter overlays because the loan is larger and replaces your primary mortgage. A second mortgage lender may be more flexible, but it will charge for that flexibility through a higher rate.
Run the Numbers on Total Cost, Not Just the Rate
Compare both options over the time you plan to keep the house. Add up the new monthly payment, the closing costs, and total interest over five years, ten years, or however long you expect to stay. A lower rate with $12,000 in fees can lose to a slightly higher rate with $1,500 in fees.
A refinance vs current mortgage calculator helps you see the break-even point on a cash-out refinance. For the full payment, remember that principal and interest are only part of the bill. Property taxes and homeowners insurance go into escrow, and they can rise after the new loan closes. Use a refinance with taxes and insurance calculator to see the real monthly payment instead of the lender’s teaser number.
Ask each lender for a Loan Estimate on the refinance and a closing cost estimate on the home equity loan. Compare the APR, not just the note rate. The APR includes most fees and gives a more honest picture of the cost. Then compare total dollars paid over your expected holding period.
A Practical Way to Choose
Start with the amount you need and how long you plan to stay. If your first mortgage is below today’s market rate and you need $75,000, a home equity loan usually wins. If your first mortgage is at or above today’s market rate and you need $150,000, a cash-out refinance usually wins. If the numbers are close, choose the option with the lower total cost over your holding period and the payment you can comfortably cover.
Get quotes from at least three sources: a bank, a credit union, and a mortgage broker. Ask for the same loan amount and term so the comparison is fair. Read the closing cost details, not just the rate. The cheaper loan is the one that charges the least for the dollars you actually need, after fees, over the time you keep the house.