If you need to borrow money to tackle a big project like a home renovation or to consolidate debt, you may be considering a home equity line of credit (HELOC) or a cash-out refinance. Both of these routes allow you access to the equity you’ve built in your home for cash, but in different ways.
A HELOC functions similarly to a credit card, where you only borrow the exact amount you need up to the borrowing limit. With a cash-out refinance, you replace your mortgage with a larger loan and pocket the difference in cash.
If you’re considering getting a HELOC or a cash-out refinance, here’s what you need to know:
- Cash-out refinance vs. HELOC
- How these products are similar
- How they’re different
- When to use cash-out refinance
- When to use a HELOC
- Frequently asked questions
Cash-out refinance vs. HELOC
A home equity line of credit, or HELOC, functions similarly to a credit card. You’ll receive a borrowing limit determined by the appraised value of your home minus the balance you owe on your mortgage. You can withdraw from your HELOC as many times as needed during the borrowing period, also known as the “draw period.”
During the draw period, you’ll make interest payments on the amount you spend. Additionally, you can also pay down your HELOC balance during the draw period to free up your amount of available credit. HELOC draw periods typically last for 10 years.
Once the draw period ends, you’ll enter the repayment period, which often lasts for 10 to 15 years. During this time, you’ll repay your principal balance plus interest.
A cash-out refinance also allows you to tap into your home equity, but you’ll receive a lump sum of cash rather than a line of credit. Essentially, you’ll refinance your mortgage for more than what you currently owe. The new loan pays off your existing mortgage and you’ll receive the remaining funds in cash. Funds from a cash-out refinance are also flexible and can be used at your discretion.
Your new mortgage will have a new interest rate and repayment term. If you can get a lower interest rate than you’re currently paying, a cash-out refinance may help you save money in interest costs over the life of your loan — especially if you opt for a shorter loan term.
Here a few key differences between a HELOC and cash-out refinance:
| Cash-out refinance | HELOC | |
|---|---|---|
| Type of loan | Replaces your old mortgage | Additional home loan, also called a “second mortgage” |
| Interest rate | Can be fixed-rate or adjustable-rate | Typically variable |
| Closing costs | Yes, typically 2% to 5% of loan amount | Typically 2% to 5% of loan amount, but some lenders |
| Fund distribution | Lump sum of cash | Can pull funds from available line of credit |
| Repayment terms | Usually 15 to 30 years | Repayment period usually lasts 10 to 15 years |
If you’re considering a cash-out refinance, be sure to compare multiple lenders.
How a cash-out refinance and HELOC are similar
Cash-out refinances and HELOCs are similar in that both borrowing options allow you to leverage the equity you’ve built in your home. Here are other common features of each borrowing option:
- Require significant home equity: You’ll need at least 20% equity in your home to qualify for most HELOCs and cash-out refinances. Equity is the appraised value of your home minus how much you still owe on your mortgage.
- Require a home appraisal: Many lenders will want you to get your home appraised to determine the value of your home and how much equity you have. The cost of a home appraisal will likely be factored into your closing costs.
- Minimum credit score requirements: You’ll generally need a 620 minimum credit score to qualify for a HELOC or cash-out refinance on a conventional loan.
Additionally, both forms of financing are secured loans that use your home as collateral. This means that if you default on payments, you risk losing your home to foreclosure.
How a cash-out refinance and HELOC are different
While HELOCs and cash-out refinances share some similarities, they differentiate in several ways:
- How you get your money: With a cash-out refinance, you’ll receive a lump sum of cash directly into your bank account. On the other hand, with a HELOC, you’ll access your funds with a credit card or special checks.
- Loan type: A cash-out refinance replaces your existing mortgage, whereas a HELOC is a second home loan that you pay in addition to your mortgage.
- Interest rates: HELOCs tend to have variable interest rates that fluctuate over time. This means that your monthly payments may be higher if interest rates rise. Cash-out refinances typically have fixed interest rates, meaning your monthly payments will remain the same over the life of the loan.
- Closing costs: With a cash-out refinance, you’ll pay all the closing costs associated with a standard mortgage. These can include attorney fees, title search fees, and appraisal fees. Some HELOC lenders also charge closing costs, but some may waive them altogether.
When to use cash-out refinance
The best time to get a cash-out refinance is when the interest rate on the new loan is lower than the interest rate that you currently have. This may happen if interest rates drop due to market changes, or if you have a better credit score and higher income than when you originally applied for your mortgage.
Cash-out refinancing can be a good idea if you want to consolidate high-interest debt with a lower-interest loan. If you need to cover a large expense, a cash-out refi can help you cover it with lower interest rates than other forms of financing, such as a student loan or auto loan.
If you’re considering getting a cash-out refinance, you can get prequalified offers from Credible in just a few minutes — checking rates is free and won’t impact your credit score.
When to use a HELOC
A HELOC can be a good borrowing option when you need to borrow money and the interest rate is lower than another type of lending product like a personal loan or credit card.
HELOCs can be especially useful if you want to make improvements to your home that can help you increase your home’s value or if you want to consolidate high-interest credit card debt.
Keep in mind that HELOCs require using your home as collateral, so make sure you’ll be able to continue to afford making mortgage payments in addition to your HELOC payments. If you default on payments, you risk losing your house.
Frequently asked questions
What are the benefits of a HELOC?
One of the main benefits of a HELOC is that you only need to pay interest on the amount you end up borrowing, not the full amount of the money available to you to borrow. This can help you save on interest charges. HELOCs are also usually a fairly affordable form of borrowing when compared to other flexible borrowing options like credit cards.
What are the benefits of a cash-out refinance?
Cash-out refinancing can be quite helpful as it allows you to access large sums of money. You can also enjoy a longer repayment period which can substantially lower your monthly payments.
How do I choose between a HELOC and a cash-out refinance?
Deciding whether a HELOC or cash-out refinance is the right fit for you depends on your preferences and financial situation. A HELOC is a great option if you want to be able to borrow cash as you need it.
A cash-out refinance offers larger borrowing amounts, but also requires interest payments on the full amount of money you borrowed. A HELOC only charges you interest on the money you end up using.