HELOC vs. Cash-Out Refinance

If you want to borrow against your home's equity, the two most common routes are a home equity line of credit (HELOC) and a cash-out refinance. They can lead to the same place, cash in hand, but they work very differently.

How a HELOC works

A HELOC is a second loan that sits behind your existing mortgage. You keep your current first mortgage as is.

• You're approved for a credit line up to a limit.
• During the draw period, often several years, you can borrow, repay and borrow again. Payments may be interest-only during this time, depending on the product.
• After that comes the repayment period, when you can no longer draw and you repay principal and interest. Payments can rise noticeably at this point.
• Most HELOCs have a variable rate tied to an index such as the prime rate. Some offer an option to fix a portion of the balance.

A home equity loan is a cousin: a second mortgage paid out as a lump sum, usually with a fixed rate.

How a cash-out refinance works

A cash-out refinance replaces your current mortgage with a new, larger first mortgage and pays you the difference. You end up with one loan at a new rate and term. More in cash-out refinancing explained.

Side by side

Your existing rate

• HELOC: keeps your current first mortgage and its rate.
• Cash-out refi: replaces it with a new rate on the entire balance.

Rate type

• HELOC: usually variable.
• Cash-out refi: fixed or adjustable options.

How funds are received

• HELOC: draw what you need, when you need it.
• Cash-out refi: lump sum at closing.

Costs

• HELOC: closing costs are often lower, and some lenders offer reduced-cost options. There may be annual fees or early closure fees.
• Cash-out refi: full closing costs on the new loan.

Payments

• HELOC: can change with rates and when the draw period ends.
• Cash-out refi: predictable with a fixed rate.

When a HELOC may fit better

• Your current mortgage rate is lower than today's rates and you want to keep it.
• You need funds over time, like a remodel paid in stages.
• You want a safety net you may or may not use.
• You plan to repay the balance fairly quickly.

When a cash-out refinance may fit better

• Current rates are similar to or lower than your existing rate.
• You want one predictable fixed payment.
• You need a large lump sum.
• You want to restructure your loan at the same time, such as removing mortgage insurance.

An example

These numbers are for illustration only. A homeowner owes $500,000 at 3.5% and wants $100,000 for a remodel. Today's cash-out refinance rate is 7%.

• Cash-out refi: the whole $600,000 would be at 7%. The interest cost on the original $500,000 rises substantially.
• HELOC: the $500,000 stays at 3.5%, and only the $100,000 is at the HELOC's variable rate, say 8.5%.

Even with a higher rate on the HELOC, the blended cost may be lower in this case. If the homeowner's existing rate were 7.5%, the math could flip.

Risks to keep in mind

• Both are secured by your home. Missing payments can put it at risk.
• HELOC rates can rise, and payments increase when repayment begins.
• Lenders can freeze or reduce a HELOC line in some circumstances.
• Borrowing against equity reduces your cushion if values fall.

Questions?

The right choice usually comes down to your current rate, how you'll use the money and how quickly you'll repay it. contact me and I'll run both options with your numbers, or start an application.