A cash-out refinance and HELOCs are two ways of utilizing equity in exchange for cash, but which is the better option for homeowners?
A cash-out refinance and a home equity line of credit (HELOC) allow homeowners to turn their property’s equity into liquid assets that can be used for any reason. With that said, that might be the only similarity between these two loan types.
A cash-out refinance replaces your original mortgage with a larger one in exchange for a lump sum. In contrast, HELOCs are a revolving line of credit you can withdraw from as needed and are separate from your mortgage payments, though your house still secures them.
We contacted a real estate investor to settle the cash-out refinance vs. HELOC debate. We’ll review both financial products, their pros and cons and let you know how to decide.
- What is a HELOC?
- Pros
- Cons
- See All 12 Items
What is a HELOC?
A home equity line of credit (HELOC) is a credit line secured by your home that you can withdraw from as needed, sort of like a credit card. Your borrowing limit is typically 80% of your home’s equity, which is the home’s value minus the mortgage balance.
You can withdraw money from your HELOC during the draw period, typically a 10-year span during which you’ll still have to make minimal payments on any withdrawn funds plus interest. After that, you’ll enter the HELOC repayment period and must repay the money you took out plus interest.
You’ll retain your mortgage and add on the HELOC, meaning you must make two separate payments. It’s like using your house as a credit card – your home is the collateral for this loan. Collateral means that your home can be taken from you if you cannot make monthly payments.
This is why it is important to always communicate with your lender. If not, you will not be able to work out a solution when you are experiencing financial difficulties.
Figure is one of our top choices for a HELOC lender because they offer fixed interest rates, a 100% online application and a quick closing process (you can get your money in as little as five days). Read our full Figure review for more details.
Pros
- HELOCs are flexible – you can borrow as much (or as little) as you need over a decade.
- Fixed-rate options are available.
- You make the cash invested in your home work for you – use it to make home improvements, buy investment properties, consolidate other debt and more.
- You can refinance the HELOC if needed.
Cons
- The line of credit stays open for a decade, so continued spending can be tempting.
- Many HELOCs are adjustable-rate or variable-rate, so the interest rate may change.
- Some HELOCs include application fees, annual fees, cancellation or early closure fees.
- The bank could foreclose on your home if you fail to pay.
- You may need a personal loan instead of accessing your home’s equity.
What is a Cash-Out Refinance?
A cash-out refinance replaces a homeowner’s mortgage with a new, larger one in exchange for a lump-sum payment equal to the difference between the two loans. This financial product can fund major renovations, consolidate debts or make a down payment on another property.
“This option can result in a lower interest rate, but it also extends your mortgage term,” says San Diego-based real estate investor Tim Gordon.
Not only that, a cash-out refinance may increase your monthly mortgage payments based on the terms set by your lender. You’ll have to go through the mortgage application process again to prove you can afford the new payments and deal with closing costs.
Rocket Mortgage (formerly Quicken Loans) is one of our top picks for cash-out refinance lenders because its online process is user-friendly. It also has an online learning center so you can be well-informed about the process as you go along. They also have some of the best customer support we’ve come across.
Pros
- Provides you with a lump sum of cash
- Lower interest rate than other loan types
Cons
- Replaces existing mortgage with a new, higher one
- Increases monthly payments
HELOC vs Cash-Out Refinance
Here’s a quick guide that breaks down the main differences between a HELOC and cash-out refinance.
| Home equity line of credit (HELOC) | Cash-out refinance | |
| Funding | Revolving line of credit | Lump sum payment |
| Repayment terms | 10-year draw period (you must make minimal payments on any withdrawn money), followed by a repayment period. | Determined by lender |
| Interest rate | Variable (some lenders offer fixed-rate HELOCs) | Fixed |
| Borrowing limit | 80% of your home’s equity | 80% of your home’s equity |
| Recommended lender | Figure | Rocket Mortgage (formerly Quicken Loans) |
How to Choose Between a HELOC and a Cash-Out Refinance
Gordon, who has capitalized on his investments by using the equity in his properties, says the choice between HELOCs and cash-out refinance depends on how much money people need and when they need it.
“Which one is superior largely depends on one's financial objectives, and whether they require access to one sum or a continuing flow of funds,” he says.
With a HELOC, you’ll be granted a revolving line of credit you can withdraw from when needed. Cash-out refinances, on the other hand, provide you with a lump sum cash payment after closing.
People with recurring payments, such as those doing renovations, should consider a HELOC since it provides more flexibility. You can take out as little or as much money as you need, and you’ll only repay the money you take out, plus interest.
A cash-out refinance may be more advantageous to those who need to make a one-time payment, such as those putting down a house.
Another thing to keep in mind is the repayment structure. HELOCs are an additional loan separate from your mortgage, though it still uses your house as collateral, and has their interest rates.
Cash-out refinances restructure your existing mortgage and replace it with a larger loan that might result in higher monthly payments. However, the refinancing process could get you lower interest rates.
Alternatives to HELOCs and Cash-Out Refinance
One alternative to HELOCs and cash-out refinances is a Home Equity Agreement, when a homeowner gives up a percentage of their equity in exchange for a lump-sum payment. Once the terms are agreed to, a lender or investor provides the homeowner with cash and puts a lien on the house until the principal balance, plus a percentage of any appreciation in the home’s value, is repaid.
On the plus side, an HEA doesn’t come with interest payments and you can be approved for one with a 550 credit score or higher, whereas HELOCs and cash-out refinances require a FICO score in the mid-600s. That said, you’ll be giving up a percentage of your home’s equity and a lien will be put on the property until the balance is repaid.
RELATED: HEA vs. HELOC
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his coverage of the New York City economy. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
We worked with San Diego-based real estate investor Tim Gordon for this story. He has used HELOCs on his investment properties to fund renovations, increase their value and make new purchases.
Frequently Asked Questions
What is the difference between HELOC and cash-out refinance?
One difference between a HELOC and a cash-out refinance is that a HELOC provides a revolving line of credit, whereas a cash-out refinance gives you a lump-sum payment. While a HELOC uses your home as collateral, the payments are separate from your mortgage. A cash-out refinance replaces your existing mortgage with a new, larger one.
Do you lose equity in a cash-out refinance?
No, you do not lose equity in your home in a cash-out refinance.
Do you pay taxes on cash-out refinance?
Sources
- Tim Gordon, real estate investor and financial expert at Gordon Buys Homes.
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.