Cash-Out Refinance vs. Home Equity Loan—What Would Be a Rational Choice?

by HMLS

Cash-out refinance and home equity loans are two mortgage products with the same root—they rely on the value of the equity you hold in your property. They may seem like interchangeable financing options on the surface but, in reality, have vastly different structures that should be considered while debt planning.

In this guide, we tackled the cash-out refinance vs. home equity loan dilemma to help you choose a product that works for you. We will take an objective look at the characteristics of both products and answer common queries like:

  • What is the better option—a cash-out refinance or a home equity loan?
  • How do you find the right lender for your situation?
  • Should you go for alternative equity-based debt products like a home equity line of credit (HELOC)?

Is a Home Equity Loan the Same as Cash-Out Refinancing?

Home equity loans and cash-out refinancing are options considered by homeowners who already have a primary mortgage on their property and want some extra cash for repairs, investment in lucrative avenues, or other expenses. Both products are similar since they help break the “house rich, cash poor” cycle by making housing assets more liquid beyond sales. That being said, they are structurally different products. Let’s cover these mortgage concepts individually with the help of examples.

Home Equity Loan—Leveraging Equity for a Mini New Loan

When you take out a home equity loan, you offer a portion of the equity you’ve built up in your residence or investment property as collateral. Say you bought a $300,000 property in 2018. You financed it with a 4%, 30-year mortgage. The loan-to-value (LTV) and down payment ratio was 70:30—you paid $90,000 down, and $210,000 was financed by the bank.

You essentially started with 30% equity, and every time you made an amortized payment towards the principal, your equity share increased. By 2022, your equity share rose to 40%, and the property value appreciated to $400,000.

If you need cash, you can offer the 40% equity share ($400,000*40%=$160,000) to another lender as collateral to obtain another mortgage of a matching value. The second mortgage, in this case, will be called a home equity loan. Keep in mind that lenders don’t let you borrow 100% of your untapped equity value.

To sum it up, you have two payments to keep up with:

  1. Amortized installments on your primary mortgage
  2. Additional installments on your second home equity mortgage

Source: OleksandrPidvalnyi

Cash-Out Refinancing—Leveraging Equity for a Bigger, Merged New Loan

Cash-out refinancing expands on the home equity concept to give you mortgage consolidation services as well. A regular refinancing loan replaces your existing debt with a new package. You owe the same amount as before, but the loan structure is tweaked with fresh (often lower) interest rates and longer or shorter repayment schedules.

When you go for a cash-out refinance loan, you get to tap into your home equity and request a larger principal sum. Let’s lock this down with an example—refer to the 2018 and 2022 values of a sample mortgage in the following table:

Mortgage Aspects20182022
Latest property value (A)$500,000$650,000
Mortgage balance (B)$400,000$320,000
Down payment/Equity value against the principal (C)$100,000
($500,000 – $400,000)
$180,000
($500,000 – $320,000)
Equity holding [(C÷$500,000)*100]20%36%
Market value of equity$100,000$234,000 (36% of $650,000)

With reference to the numbers above, if you choose a cash-out refinance loan in 2022, the lender will pay off your mortgage balance and offer you a percentage (say 70%) of the equity. You get rid of your old loan while keeping $163,800 ($234,000*70%) as extra spending cash by leveraging your equity.

Your current loan obligation would be the sum of your old outstanding mortgage and the equity cash-out sum—$483,800 ($320,000 + $163,800). It’s your primary mortgage, but you have only one stream of installments to worry about.

Is It Better To Use a Cash-Out Refinance or Get a Home Equity Loan?

Choosing between cash-out refinancing and home equity loans can be difficult if you’re not sure which product will benefit your financial situation the most. They may seem equally sensible, but you need to tread carefully because you have your home equity on the line, and it’s not advisable to commit to mortgage payments that feel burdensome.

Cash-out refinance (also called cash-out refi) is considered a better (and more popular) financing option than a home equity loan because it consolidates debt and streamlines closing costs. Still, borrowers are sometimes wary of refi loans because these products reassign existing mortgages, and that may not be the right decision for everyone.

The ultimate choice should depend on the particulars of your situation. A good strategy is to evaluate the home equity loan vs. cash-out refinance issue from a logistical point of view.

Source: Scott Graham

What Is the Difference Between a Cash-Out Refinance and a Home Equity Loan?

If you’re conflicted between a cash-out refinance and a home equity loan, start crunching numbers. Examine the following logistical components:

  1. Existing mortgage
  2. Equity-based borrowing capacity
  3. Interest rates
  4. Closing costs

Existing Mortgage

Whether you want to keep or discard your existing mortgage plays a major role in the decision-making process. Cash-out refi allows you to replace an undesirable mortgage plan with a more feasible option. You can find lenders who offer low interest rates or request a new amortization schedule that helps you repay on more lenient terms.

Keep in mind that tweaking one variable impacts the others, and the negative will most likely include a positive. Some cash-out borrowers are okay with interest rates higher by a few points because the loan comes with a short repayment window. They settle the debt quickly and reduce their overall financing cost.

If you don’t want to touch your existing mortgage plan, a home equity loan is a viable remedy for extra capital.

Equity-Based Borrowing Capacity

Both cash-out and home equity lenders require the borrower to have a minimum of 20% equity in the property before they extend the funds. The requirement comes from basic prudence standards followed in the industry—a borrower is more likely to default if they owe more than 80% of the home’s value.

Certain home equity lenders have loosened their equity-based eligibility requirements. If the borrower has an excellent credit score and a steady stream of income, they may qualify for a loan with a minimum of 15% equity.

Interest Rates

You get the best interest rates with cash-out refinance because the lender is competing with a primary mortgage. Depending on your preference, you can opt for lenders who offer fixed-rate and adjustable-rate mortgages.

Home equity loans are pricier, with usually 3%–5% points higher interest rates than cash-out loans, which makes them unappealing as long-term options. Combined with your primary mortgage obligation, you may be signing up for larger monthly payments.

Source: Mikhail Nilov

Tax implications of both options are the same—you can claim your interest payment as a deduction as long as you used the sum for:

  • Repairs
  • Structural additions
  • Any other qualifying home-improvement construction

Closing Costs

Closing costs are calculated as a percentage (2%–6%) of the loan, so your immediate expenses will be greater if you go for cash-outs. A home equity loan has relatively lesser closing costs as you’re borrowing a smaller amount to begin with.

Remember that closing costs are one-time expenses, and if you cannot afford the outlay, the cash-out refi lender typically deducts it from the loan amount.

How To Find a Suitable Lender

Even after you make a choice, finding a lender with a deal that works for you can be challenging. Generally speaking, you have to choose a finance provider based on what packages you qualify for and how fast you need the funds. You can go for:

  1. Conventional bank loans
  2. Government agency-backed loans
  3. Hard money loans

Conventional Bank Loans Work for Borrowers With Good Credit

Banks, credit unions, and other traditional lending organizations offer conventional home equity and cash-out loans. To qualify for either of these loans, you need to have:

  • High credit score, at least in the mid-600s
  • Debt-to-income (DTI) ratio of 43% or lower
  • Sufficient equity
  • Reliable income source
  • Clean credit history—no frequent defaults, missed tax returns, or other symptoms of financial delinquency

Be prepared to gather and submit financial and personal documents throughout the screening process, which can last for about 30–90 days. Most banks ask for W-2s, pay stubs, bank statements, and credit card reports dating back a few months.

Government Agency-Backed Loans Cater to Low-Income Group Borrowers

Government agencies like the Federal Housing Administration (FHA) and Veteran Affairs (VA) run loan programs with below-market interest rates to provide housing to low-income and disadvantaged groups. You can qualify for suitable programs with minimum credit scores of 500–580. 

Other eligibility requirements are the same as for conventional loans, but you may have to submit additional paperwork regarding:

  1. Proof of residency in the property for the past 12 months (utility bills and such)
  2. Existing mortgage payment history

Because the allotted funding is limited, many lenders under FHA or VA also ask borrowers to submit statements to express why they should be considered for the loan. Borrowers who use 100% of the property for commercial, rental, or investment purposes don’t qualify.

Source: Kampus Production

Choose Hard Money Loans if You Want Funds Fast With Minimum Scrutiny

A hard money loan is capital offered by a private source rather than a regulated traditional lender. You qualify for funds based on the collateral instead of your credit worth and financial health. The paperwork is light because there is usually no scrutiny of bank documents, income sources, or existing debt, and you can collect the funds within a week or two.

Hard money loans have 1.5–3 times higher interest rates than standard mortgage loans. The repayment window is short (1–3 years), so your overall cost of financing is typically at par with long-term loans. 

You can also use these loans for bridge financing if you want funds immediately. Forward your investment, construction, or renovation work with the hard money loan and pay it off as soon as you qualify for a conventional one.

Hard money home equity or cash-out lenders require you to hold at least 80%–90% of the equity to ensure you have enough skin in the game and are less likely to default.

Get Cash-Out and Home Equity Loans Fast With Hard Money Loan (HML) Solutions!

Loan turndowns and delays are common when asking for cash-out and home equity loans from conventional lenders. If you want speedy alternative funding, Hard Money Loan (HML) Solutions can serve you well!

HML Solutions is a Florida-based private lending group that:

HML lenders are a team of veteran investors and entrepreneurs who believe in customized services with a solution-centric approach. They offer all types of competitive loan packages, including bridge, refinance, cash-out refinance, fix-and-flip, rehab, and construction—no down payment required. You qualify based on the appraised value of the property and the amount of equity you hold—the minimum equity requirement is flexible. Unlike traditional lenders, HML Solutions doesn’t question your funding needs. You can use the loan for:

  • Home improvements
  • Debt consolidation
  • Credit building (by paying off other debt)

Apply for an HML Solutions loan to discuss your case with a professional lender and find out which equity-based package would work for you.

Source: Jason Goodman

HML Lenders Charge Competitive Rates and Have Low Closing Costs 

HML Solutions is all about providing maximum convenience to borrowers. Regardless of the package you choose, the lenders don’t ask you for:

  • Down payments 
  • Exorbitant closing costs
  • Intense paperwork submissions

Check out the table below to get an idea of the lending terms you can expect:

ComponentsHML Solutions Loan
Minimum credit scoresNot required
Funding range$100,000 to $50,000,000+
LTV (loan-to-value) offeredUp to 70% of the lower of:
Purchase price 
Appraised value
Interest rate (depends on LTV)9.99%–12% 
Rate typeFixed
Tenure1–3 years
Installment typeInterest only (no amortization)
Funding time3–14 days
Origination fee2 points or 2%
PaperworkProperty documents
Old mortgage papers (only for refinance packages)
Basic business documentation (for commercial real estate loans)

HML Solutions has a 5-star Google rating—the group’s prime service benefits include:

  • Transparent processing
  • Direct, time-sensitive communication
  • High tolerance for difficult-to-lend deals
  • Guaranteed funding commitment (after approval)
  • Major focus on building strong client relationships

HML Solutions—Lending Process

The table below outlines the crucial stages of the lending process at HML Solutions:

StageWhat Happens
Pre-approvalYou drop an online loan application on HML Solutions’ website. A lender takes a quick look at your request and calls you to discuss the loan. HML lenders are formal yet friendly and listen without judgment
AppraisalIf the lender wants to go forward with your deal, they will appraise your property to factor in its latest value and risk variables. After basic due diligence, they will present you with a tailor-made loan package
FundingIf you accept the package, HML’s legal partners will release the funds within 3–14 days, depending on the level of documentation required

Apply for HML’s cash-out and home equity packages today to get the highest possible funding for your deal.

Source: Towfiqu barbhuiya

If you have any investment-worthy deals, HML lenders would love to take a look. Contact them for asset-based funding related to:

  • Business acquisition
  • Startups
  • Bank-foreclosed properties
  • Purchase of residential land or a commercial plot

Should You Go for a Home Equity Line of Credit (HELOC)?

HELOC often comes up as an alternative to cash-out refinance and home equity loans. A HELOC is not a lump sum loan—rather a credit limit set up in your name according to your equity holdings. You can collect funds as you please, and the interest is charged only on the amount you’ve withdrawn. It works like credit card financing for a renovation strategy stretched out over several years or plain emergency funding for unplanned personal expenses.

The HELOC vs. home equity loan vs. cash-out refinance dilemma can be solved by understanding the following aspects:

  1. Interest rates—HELOC carries high interest rates similar to home equity loans. Cash-out refinancing is still your cheapest option. Keep in mind that you pay at real-time interest rates with HELOC, so you’re vulnerable to inflation-based rate fluctuations
  2. Closing costs—HELOC and home equity loans have smaller closing costs than cash-outs. For HELOC, the cost is calculated on the total amount assigned to the credit
  3. Other fees—HELOC products may require additional payments that increase your operational costs, or worse, eat your equity away. Examples include:
    1. Membership or account maintenance fees (annual)
    2. Transaction fees
    3. Early payoff or early termination fees
    4. Non-usage/inactivity fees
    5. Minimum balance fees

If you go for a HELOC, be careful of overspending and keep track of the latest interest rates. 

Can You Get a Home Equity Loan After Refinancing?

You can get a home equity loan after refinancing, provided you have enough equity remaining in the property. For example, if you have 25% equity in your property, a lender may agree to offer you a loan for 5%–10% equity. It’s all about meeting a lender’s qualification requirements.

Featured image source: RODNAE Productions

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