Cash-out refinance vs. home equity loans

When you’ve owned a home for a long time, there’s a good chance you have significant home equity. Whether from making regular mortgage payments, an increase in your home’s value, or a combination of the two, home equity can be a valuable financial resource.

If you want to access your home equity, two of the most common methods are a cash-out refinance and a home equity loan. Each has pros and cons, and neither is perfect for everyone. By understanding your financial goals and how each works, you can make an informed decision.

What is a cash-out refinance?

A cash-out refinance replaces your existing mortgage with a new loan. When the new loan is approved, the proceeds pay off your old loan, and you keep the difference. Because it’s a larger mortgage, you may have higher monthly payments, a longer payoff period, or a higher interest rate. It’s wise to consider the costs and compare them to your current loan before refinancing.

You can get a cash-out refinance if you’ve had your mortgage loan long enough to build enough equity in the home. Many homeowners choose cash-out refinancing when the value of their home increases and they want to borrow money to pay for home improvements or other projects. If you believe your home value has risen significantly since you bought it and need a large sum of cash, a cash-out refinance is an option to tap into your home equity.

How a cash-out refinance works

Getting a cash-out refinance starts with applying for a new mortgage loan. You’ll need a loan larger than your current mortgage balance to receive cash back when the loan closes. The new mortgage replaces your old mortgage as your primary home loan, and you’ll only have to make payments on the new loan going forward.

The maximum you can borrow is determined by your home’s value, your home equity (the value of your home minus your current mortgage balance), your credit history, and other factors from your finances. Remember, you must also pay closing costs and any other fees associated with the new mortgage loan.

The funds from a cash-out refinance are tax-free and can be used in any way you like. Most homeowners use the money for renovations, but you can use it however you see fit.

Here’s an example: Suppose your home is worth $400,000, and your mortgage balance is $200,000. If you refinance your home with a new $250,000 loan, you’ll walk away with $50,000 in cash, minus closing costs and fees. Your monthly payments will likely increase, as the new loan is larger. Use our refinance calculator to estimate your new monthly payments.

How much equity can you cash out of your home?

Homeowners typically can’t get a loan for the entire value of their home. Many loans require you to leave at least 20% equity in the home, though requirements vary based on the lender, loan program, and your finances.

For conventional and Federal Housing Administration loans, you must leave 20% equity in your home after the cash-out refinance. Veterans Affairs loans are an exception, with loans supported up to 100% of the property’s value.

What is a home equity loan?

Like a cash-out refinance, a home equity loan allows you to borrow the equity in your home. It’s a second mortgage secured by your home and has a separate payment from your original loan. Home equity loans typically have higher interest rates than first mortgages.

Rocket Mortgage® now offers Home Equity Loans for primary and secondary homes.¹

How a home equity loan works

Because a home equity loan is separate from your original mortgage, the loan terms on your original mortgage stay the same. After the home equity loan closes, you’ll receive a lump-sum payment from your lender, which you’ll repay in monthly installments at a fixed rate.

That’s different from a home equity line of credit, or HELOC, which typically allows you to draw funds multiple times, and payments can vary based on your balance.

Loan restrictions

When you take out a home equity loan or cash-out refinance, you’ll typically be limited to borrowing up to a specific amount based on the value of your home, your income, and your other outstanding loans, including credit cards.

The maximum you can borrow based on the value of your home is your loan-to-value ratio. Your loan amount divided by the property value gives you the LTV. The LTV tells you what percentage of the home’s value you’re borrowing, and the remainder is your home equity, including the new loan.

DTI is short for debt-to-income ratio. Your DTI ratio is calculated by dividing your total monthly debt payments, usually based on what’s listed on your credit report, by your monthly income. Most lenders set a maximum DTI ratio to ensure borrowers can afford to repay new loans.

Home equity vs. cash-out refinance: Which one makes sense for you?

If you want to quickly compare the most important aspects of a cash-out refinance or home equity loan, focus on these key areas:

Let’s delve deeper into the differences and similarities between cash-out refinances and home equity loans.

Similarities between cash-out refinances and home equity loans

Cash-out refinances and home equity loans share similarities that make both options appealing to homeowners. Both allow you to borrow based on the value of your home, and you may be able to quickly get the cash you need for home improvements or other financial needs.

• You get your money quickly. You can walk away with a lump-sum cash payment up to 3 business days after closing. The waiting period gives borrowers time to exercise their right of rescission, which allows them to cancel if they change their minds.
• Your home is the security for the loan. Your home serves as collateral for both loans. Since the loans are secured, you’ll likely get lower interest rates than you would with unsecured loans.
• Generally, you can’t access 100% of your home’s equity. Most lenders and loan types require borrowers to leave some equity in the home.

What are the differences between home equity loans and refinances?

While home equity and cash-out refinance loans share similarities, they have two key differences:

• Cash-out refinances are first loans, while home equity loans are second loans. Cash-out refinances pay off your existing mortgage and give you a new one, while a home equity loan is a separate loan considered a second mortgage.
• Cash-out refinances have better interest rates. Since cash-out refinances are first loans, meaning they’ll be paid first in the case of a foreclosure, bankruptcy, or judgment, they typically have lower interest rates.

When a home equity loan makes sense

Home equity loans can be a good choice for borrowers looking for money to cover renovations, big purchases like a car, or a down payment on an investment property. These loans allow you to maintain your current interest rate on your original loan while taking out a new loan that you can pay down separately. These are particularly beneficial if you already have a low interest rate or have made significant progress paying down your primary mortgage balance.

If you’re unsure how much cash you need or don’t need all at once, consider looking into a HELOC. It’s a good idea to assess whether a HELOC or cash-out refinance makes more sense based on your financial goals. Rocket Mortgage does not offer HELOCs at this time.

When a cash-out refinance makes sense

If your home’s value has increased or you’ve built up equity through mortgage payments, a cash-out refinance may be the right option. Cash-out refinancing may be a lower-cost option to borrow money. If you have major expenses coming up, a cash-out refinance can be a great way to cover them while paying less interest compared to other options.

Remember, with either cash-out refinance loans or home equity loans, you could lose your home to foreclosure if you don’t keep up with payments as agreed.

FAQs for home equity loan vs. refinance

Now, let’s answer some frequently asked questions about home equity loans versus cash-out refinances.

Can you refinance your home equity loan?

Yes, you can refinance your home equity loan. Refinancing can be a good option when loan interest rates are lower than when you took out the original loan or if you want to switch from an adjustable-rate to a fixed-rate loan.

Is a home equity loan cheaper than a refinance?

Home equity loans (and home equity lines of credit) usually have significantly lower closing costs than cash-out refinances. Sometimes, the lender will even absorb closing costs, too.

While home equity loans and HELOCs usually have higher interest rates, they may be a better option than a cash-out refinance if their rates are comparable to your current mortgage rate, especially if you’re only borrowing a relatively small amount.

What are the alternatives to a HELOC or cash-out refinance?

If you’re considering refinancing to cover a small project or pay off a small debt, a personal loan or credit card with a low interest rate may be the best option. With either of those, you can avoid the closing costs associated with cash-out refinances, home equity loans, and HELOCs, and your home isn’t on the line if you can’t afford payments.

Will I lose my home equity when I refinance?

In short, no. You won’t lose equity when you refinance your home, though you may decrease it. Your home equity will fluctuate based on how much of your mortgage you’ve paid off and the impact of market shifts on your home’s value. Tapping into your home equity to make improvements or fund renovation projects can increase your home’s value and, with it, your equity.

The bottom line: What you choose depends on your goals

Both cash‑out refinances and home‑equity loans can unlock the value you’ve built in your home – the key is choosing the option that fits your bigger picture. If you need a sizable lump sum and don’t mind replacing your current mortgage, a cash‑out refi can streamline everything under one payment and often deliver a lower rate. If you’d rather preserve a great first‑loan rate and take out a smaller, separate loan, a home‑equity loan keeps your original mortgage intact while still giving you quick access to cash.

Whichever path you follow, make sure the numbers work for your budget, the purpose aligns with your goals, and you’re comfortable putting your home on the line. When you balance those factors, tapping your equity can become a strategic step toward remodeling that kitchen, consolidating high‑interest debt, or funding a milestone that matters to you.

Ready to get started? Start an application online to see how much cash you can access with a cash-out refinance. You can also call us at (833) 326-6018.