HELOC vs. cash-out refi: 5 things to know

A couple seated on their living room sofa review their finances using a laptop and documents.Image: A couple seated on their living room sofa review their finances using a laptop and documents.

In a Nutshell

A HELOC and cash-out refinance are two different ways to tap equity that you have in your home. Here's what to know about how they work and when to consider one over the other.
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If you own your home and have built enough equity in it, there are different ways you can access that equity.

Two of those options are a cash-out refinance and a home equity line of credit (HELOC). As you compare a HELOC vs. a cash-out refi, it’s important to understand how they function and which situations each may be best suited for.

Here are five things to consider before you make a decision.



1. How a HELOC works

A HELOC is a form of revolving credit that functions much like a credit card. Rather than giving you an upfront, lump-sum payment of your equity, a HELOC gives you a credit line that you can borrow against, pay off and repeat the process.

For example, let’s say you take out a HELOC for $100,000. You can borrow against that amount at any point during the HELOC’s draw period, and you’ll typically make minimum or interest-only payments on the amount that you borrow during that time.

Once the draw period is over, your HELOC enters a repayment period, at which point you’ll need to make regular monthly payments to pay off your remaining balance. Draws may no longer be allowed during this period.

HELOCs are typically harder to qualify for than cash-out refinance loans because a HELOC is a subordinate or second mortgage loan. This means that if you default on your payments and your home is foreclosed on, your primary mortgage lender gets the first claim on the proceeds of the foreclosure sale.

2. How a cash-out refinance works

A cash-out refinance is a new mortgage loan that replaces your current mortgage loan for more than you owe. In addition to the amount needed to pay off your existing mortgage loan, the lender will also give you cash.

Cash-out refi amounts may be limited to a certain percentage of the home’s appraised value — often 80% of your loan-to-value ratio.

For example, if you owe $200,000 on a home whose estimated worth is $400,000 and want to borrow $100,000 from your home equity, you’d apply for a $300,000 mortgage. If approved, you’d receive $100,000 in cash upon closing the loan.

You’ll then pay that balance over a set repayment period, just like you were doing with your original mortgage.

3. What is the difference between a HELOC and cash-out refinance?

As you compare a HELOC vs. a cash-out refinance, you’ll notice several key differences in how they work.

Loan terms

With a HELOC, there’s a draw period and a repayment period. During the draw period, you can take withdrawals from the line of credit and pay them back over time as long as you don’t exceed your credit limit.

You typically only have to make minimum or interest-only payments during this time, but once the draw period is over, your remaining balance will be amortized over the repayment period, which can last as long as 20 years — and you’ll make monthly installment payments until it’s paid in full.

In contrast, a cash-out refinance functions like a traditional mortgage loan. You’ll choose your repayment term — often 30 years or 15 years — and make installment payments throughout that period.

Interest rates

HELOC interest rates are typically variable, which means that they can go up or down over time along with market rates. If market conditions cause interest rates to go up, your HELOC may get more expensive over time. But the opposite may also be true if market rates go down.

In some cases, HELOCs may allow you to convert some or all of your balance to a fixed-rate loan that you can pay off over a set period.

With a cash-out refinance, you may be able to choose a fixed interest rate or an adjustable interest rate. If you opt for an adjustable-rate loan (ARM), your interest rate will be fixed for the first three to 10 years, after which it will switch to a variable rate and fluctuate based on market conditions.

Availability of funds

A HELOC gives you a line of credit that you can draw upon and pay off repeatedly throughout your draw period. If you don’t need all of the money at once, that can be an advantage.

You can typically access funds from your line of credit via a bank transfer, debit card or paper check.

With a cash-out refinance, you’ll receive the full amount upfront when your loan closes. You’ll typically get the funds in the form of a check or a wire transfer.

Closing costs

For HELOCs that have closing costs, lenders typically charge between 2% and 5% of the credit limit. But in many cases, you can get a HELOC without any closing costs at all. Keep in mind that some HELOCs charge annual fees.

In contrast, when you take out a cash-out refinance loan, you’re paying closing costs on the full principal balance, not just the amount you’re taking from your equity. These costs typically range from 2% to 5% of the loan balance.

Tax deductibility

Because a cash-out refinance is a primary mortgage loan, the interest you pay on the loan may be tax deductible on the first $750,000 you borrow. In contrast, you may only be allowed to deduct interest paid on a HELOC if you’re using that line of credit to buy, build or substantially improve the property you’re using as collateral.

In other words, if you’re considering a cash-out refinance or HELOC for debt consolidation, college expenses, emergency needs or anything that’s not related to the home, the interest paid may be deductible on the cash-out refinance but may not on the HELOC.

Consult with a tax professional to learn what may be permitted in the current tax year.

4. When to consider a cash-out refinance

Because the upfront cost of a cash-out refinance can be higher than a HELOC, you’ll want to think about the pros and cons of applying for a cash-out refi.

Here are some things to consider whether …

  • Your credit has improved, or market rates have gone down, and you can get a better interest rate on the new loan than what you’re paying now.
  • You want all of the money upfront and don’t need long-term access to a credit line.
  • You only want one monthly payment to worry about.
  • You’d prefer a fixed interest rate instead of dealing with rate fluctuations.
  • You plan to live in the home long enough to recover the loan’s closing costs.
  • Your budget can afford the higher monthly payment.
  • You want to be able to deduct all of the interest that you’re paying on your loan. Closing costs tend to be lower with a HELOC than with a mortgage.

5. When to consider a HELOC

A HELOC may also be worthwhile if you plan to stay in your home for several years. You may not be able to take full advantage of the line of credit if you sell the home and move before your draw period ends.

On the other hand, a HELOC may be preferable to a cash-out refinance if you’re not planning to stay in the home for the long run.

With that in mind, here are some situations where it might be better to choose a HELOC over a cash-out refinance.

  • You don’t need the full amount upfront but want the flexibility to access your equity at different times over the HELOC’s draw period.
  • You’re not sure you’ll need all of the funds, and you only want to pay interest on the amount you’ll actually use.
  • You’re not concerned about a variable rate.
  • You’re OK with making two monthly payments: one for your primary mortgage loan and another for your HELOC.
  • You plan to live in the home long enough to take full advantage of the HELOC.

What’s next

As you determine whether it’s a good idea to borrow from your home’s equity, you’ll want to as yourself these questions:

  • How long do you plan on living in the home, and is it long enough to make the HELOC or cash-out refinance worth it?
  • Is your credit good enough that you can qualify for a low interest rate?
  • What are the current interest rates?
  • How much equity do you currently have in your home, and is it enough to achieve your goals?
  • How much money do you need to borrow?
  • Can you afford to pay the closing costs and the additional monthly payment?
  • Are you concerned about foreclosure if you can’t keep up with your monthly payments?

About the author: Ben Luthi is a personal finance freelance writer and credit cards expert. He holds a bachelor’s degree in business management and finance from Brigham Young University. In addition to Credit Karma, you can find his wo… Read more.