The Pros and Cons of a Home Equity Loan Vs. a Cash Out Refinance

Sponsored Content: As you make mortgage payments, you can turn some of your equity into cash with home lending products.

Two popular options are home equity loans and cash out refinances. They both let you take advantage of your equity, but with one main difference: A cash out refinance from Discover® Home Loans or another lender replaces your old loan, but a home equity loan is a second loan with its own payment.

This difference makes each loan type suited to different goals. We’ll dive into the pros and cons below so you can see which one is right for you.

Pros of a Home Equity Loan

Lower Closing Costs

Most home equity loans feature low or no closing costs. This can limit the overall cost of the loan to interest charges alone.

Low-Rate Access to Your Equity

When national interest rates are high, you may not be able to improve your current mortgage rate through a cash out refinance.

A home equity loan lets you tap equity without affecting the rate of your original mortgage.

Cons of a Home Equity Loan

Adds A Monthly Payment

Home equity loans don’t replace your existing mortgage. That means you’ll have an extra monthly payment in addition to your monthly mortgage payments.

This can reduce your monthly cashflow. You’ll also have more expenses to track, and this may increase your chances of missing a payment.

Higher Rates than First Mortgages

Home equity loans are typically “second lien” loans. They are often taken out in addition to an existing primary mortgage. This makes them riskier for the lender, so rates might be higher on average.

Pros of Cash Out Refinance

Lower Rates

Cash out refinances tend to come with lower interest rates since they’re “first lien” loans.

Easier Eligibility Requirements

Lenders tend to be less strict in their cash out refinancing requirements than with home equity loans. This is due to their first lien position that replaces your original mortgage.

Cons of Cash Out Refinance

Higher Closing Costs

Cash out refinance closing costs tend to be higher than home equity loans because they will be taken out for an amount large enough to refinance an existing mortgage and provide additional cash from the equity in a home.

 A High-Rate Economy

Getting a cash out refinance in a high-rate environment could stick you with a higher monthly payment if your refinanced loan includes a higher rate. Even though refinances often have lower rates than home equity loans, replacing a mortgage with a loan that has a higher rate than an existing mortgage will mean more interest charges over the life of the loan in many cases.

Closing Thoughts: Home Equity Loan vs. Cash Out Refinance

Neither one of these is entirely better than the other — they are best suited for different situations.

A cash out refinance replaces your old loan, so it can be an excellent choice when interest rates are low and you’re looking to minimize costs and financial complexity. Just keep in mind you might have to pay more closing costs depending on what your lender offers.

If you’re confident in your ability to manage an additional payment, a home equity loan could be the better option. This is especially true when interest rates are high — you don’t want to replace your mortgage with a refinanced loan at a higher rate.

Make sure you weigh each option’s costs and benefits carefully before moving forward with either loan product.

About Discover Home Loans

Discover Home Loans provides home equity loans and mortgage refinance options with a range of benefits for qualified homeowners. Find options that fit within your budget at discover.com/home-loans. © 2023 Discover Bank, Member FDIC | NMLS ID 684042