Home prices have risen rapidly in recent months, and many homeowners are weighing a cash-out refinance vs. a HELOC to tap into their growing equity. Both a cash-out refinance and a home equity line of credit (HELOC) allow you to take money out of your equity, so you can pay for home renovations or other large expenses.
When considering a cash-out refinance vs. HELOC, compare details such as costs and how the funds are disbursed to decide which is right for you.
Differences between a home equity line of credit and cash-out mortgage
A HELOC and a cash-out refinance are financial instruments that allow you to tap the equity in your home. Equity is the difference between what you owe on the house and what the home is worth. The risk to both loans is your home is used as collateral, meaning if you fail to make monthly payments you could lose your house.
With a cash-out refinance, your existing mortgage is replaced with a new mortgage for more than the amount you currently owe on your home. You’ll receive the difference between what you owe on the old mortgage and the size of the new mortgage as cash. You’ll then pay off the entire mortgage in regular monthly installments. If you get a fixed-rate refinance, the interest won’t change for the life of your loan.
A HELOC provides you with a line of credit tied to the equity on your house. A line of credit is similar to a credit card — you can use it up to a set limit. You have the flexibility to take money out as you need it, although there may be a minimum draw. HELOCs, which are also known as second mortgages or junior liens, usually have an adjustable interest rate, so your payments can change. HELOCs have a draw period, often 10 years, when you can draw on the line of credit, and a payback period, typically 20 years, to pay it back.
You’ll find some similarities when comparing cash-out refi vs. HELOC. For example, the amount of equity in your home determines how much money you can access.
HELOC vs. cash-out refi: Key differences
- A cash-out refi is a new mortgage, while a HELOC is a line of credit.
- You get all the money upfront with a cash-out refi. You withdraw money as you need it with a HELOC.
- You’ll repay a cash-out refi just like any mortgage based on the terms of your loan. With a HELOC, your payments are based on the amount of money you’ve taken out, not the entire amount available.
Pros and cons of a cash-out refinance
When you get a cash-out refinance, you replace your current mortgage with a new one. If interest rates are lower than when you took out your original loan, you may be able to get cash out and a lower monthly payment. You also continue to have just one mortgage payment. When you use a HELOC, your mortgage payment and HELOC payment are due each month. Cash-out refinance mortgages also typically have lower interest rates than HELOCs.
It may be easier to qualify for a refinance than a HELOC because the creditor that holds your mortgage is paid off first if you default and your home is sold to pay off debts. The lender that holds the HELOC is second in line, so it may have higher qualification standards.
The biggest drawback to refinancing is high closing costs, which are typically 3% to 6% of the total loan amount.
|Cash-out refinance pros and cons|
|Lower interest rate||Higher closing costs|
|Requires only one monthly payment||No flexibility on when you receive the money|
|Easier to qualify for|
Pros and cons of a home equity line of credit
HELOCs have several advantages for homeowners who want to take cash from their home. HELOCs are flexible and allow you to take the money out when you need it, so they may allow you to be better prepared when you face a large, unexpected expense.
With a typical home equity line of credit, a checkbook or credit card is tied directly to your line of credit, so it’s very easy to access the money. You only make payments on the amount you have borrowed, not the entire amount you’re eligible for.
You may be able to access up to 95% of the equity in your home, depending on the kind of loan you have and the lender you’re working with. With an FHA loan, the limit is 85%. The lender will add the amount you owe on your first mortgage and the amount you’re eligible for with the HELOC to confirm the combined amount is 85% or less of the value of the home.
But some aspects of a HELOC may not be attractive to all homeowners.
When you use a line of credit, repaying means you have to make a monthly HELOC payment and a mortgage payment. Many HELOCs have an adjustable interest rate, meaning the rate can go up over the life of the loan. The HELOC also has a limited time, known as the draw period, when you can take money out. You may not have to repay the principal during the draw period. Ten years is a typical draw period, with 20 years to repay the amount.
Taking out a HELOC can be costly. You may have to pay for services such as an appraisal and title search before opening the account. Lenders may also charge fees with a HELOC, including an annual fee and a fee per transaction.
Opening a HELOC may limit your ability to refinance your home in the future. You might have to ask your HELOC lender to approve a refinance. If the lender won’t approve it, you’d have to pay off your HELOC to refinance.
HELOC Pros and Cons
|Flexible about when you get the money||High fees possible|
|Easy to use||Limited draw period|
|Ready if an emergency need arises||Interest rates can go up|
|Adds second payment on house|
When is it better to cash-out refinance your home vs. getting a HELOC?
If you’re calculating the costs to refinance or get a home equity line of credit, deciding which is best depends on your situation and how you plan to use the money.
If you want to have access to the cash as you need it, a HELOC might work for you. For example, you can withdraw some money every semester to pay your child’s college costs. The money is also available for emergencies. Refinancing your mortgage for smaller expenses, such as a semester’s tuition or car repairs, is an expensive alternative to using a line of credit because of the closing costs required to refinance.
With a cash-out refinance, you get the money in a lump sum at the start of the loan. That makes sense if you have a specific plan and immediate use for the money, such as financing a large home renovation project or paying off high-cost loans.
Cash-out refinance vs. HELOC FAQs
Can you refinance a home equity loan into a mortgage?
If you have enough equity in your home, you may be able to use a cash-out refinance to pay off the HELOC. However, you may have to get approval for the refi from your HELOC lender, and that lender can refuse to let you refinance unless you pay off the line of credit first.
Can you get a HELOC after a cash-out refinance?
That may depend on how much of the equity you took out of the house. The lender will consider the combined loan-to-value (CLTV) ratio of your mortgage and home equity line of credit. Many lenders limit the CLTV to 80% or 85% of the home’s value, although some lenders may approve a HELOC up to 95% of CLTV. If you took a lot of equity out in the refinance, there may not be enough left to tap with a HELOC.
Are HELOCs and cash-out refinances tax-deductible?
You may be able to deduct the interest you pay on a HELOC if you use the money for home improvements. If you use the money for other purposes, such as paying off credit card debts, the interest isn’t deductible.
Consult a professional tax advisor on issues such as whether any interest or charges are tax-deductible in your situation.
Trying to decide whether a HELOC or cash-out refinance is right for you? Talk to a local Finance of America Mortgage Advisor today to learn more about your options.