Cash-Out Refinance vs. Home Equity Loan or HELOC: Which Is Better for You?
If you want to access your equity without selling your home, you have three main options: a cash-out refinance, a home equity loan or a home equity line of credit (HELOC).
A cash-out refinance and home equity loan provide a lump sum of money, making them well suited for large, one-time purchases. A HELOC gives you access to a revolving credit line, allowing you to borrow funds over time as you need them. Understanding how these tools work can help you choose the best fit for your situation.
- A cash-out refinance replaces your current mortgage, while home equity loans and HELOCs are taken out as a second mortgage.
- A home equity loan can be a good fit if you want to fund a major, one-time expense like debt consolidation or college tuition.
- HELOCs are best if you’ll need funds for multiple expenses over several years.
At a glance: Cash-out refinance vs. home equity loan vs. HELOC
| Cash-out refinance | Home equity loan | HELOC | |
|---|---|---|---|
| Payout structure | Lump sum | Lump sum | Credit line |
| Interest rate type | Fixed or adjustable rate | Fixed rate | Variable rate |
| Closing costs | 2% to 6% of the loan amount | 2% to 5% of the loan amount | 2% to 5% of the credit line |
| Tax benefits | You may qualify for the home mortgage interest tax deduction. Additionally, the interest you pay may be tax deductible if the cash was used for certain home improvements. | Your interest may be tax deductible if you used the loan proceeds for substantial home improvements. | Your interest may be tax deductible if you used the proceeds for substantial home improvements. |
| Equity needed | At least 20% | At least 15% | At least 15% |
How does a cash-out refinance work?
With a cash-out refinance, you replace your existing mortgage with a new, larger loan. After paying off your old mortgage, the remaining funds are yours to “cash out” and use however you wish, whether for debt consolidation, home improvements or other expenses.
You’ll pay 2% to 6% of the loan amount in closing costs on a cash-out refinance, which includes origination and appraisal charges. It’s a good idea to weigh the potential benefits (such as a lower interest rate) against the costs to determine if a cash-out refinance makes financial sense.
You’re typically limited to an 80% loan-to-value (LTV) ratio with a cash-out refinance, meaning you can borrow up to 80% of your home’s value. Eligible military borrowers can get a VA cash-out refinance with a maximum 90% LTV ratio, however. If you’re taking out an FHA cash-out refinance, you may qualify with a credit score as low as 500. Otherwise, you’ll need at least a 620 score for a conventional or VA-backed cash-out refi.
Pros and cons of a cash-out refinance
Pros
- You can access some of your equity without selling your home.
- You may be able to secure a lower mortgage rate.
- You can consolidate high-interest debt.
Cons
- You’re taking on a bigger loan and potentially higher monthly payments.
- Closing costs can be as high as 6% of the new loan amount.
- Requirements are often stricter than a traditional refinance.
Should you get a cash-out refinance?
A cash-out refinance may make sense if:
- You have at least 20% home equity.
- You’d prefer to only have one monthly payment.
- You can get a mortgage rate that’s lower than your existing rate.
- You want to consolidate high-interest debt.
How does a home equity loan work?
A home equity loan is a type of second mortgage that you take out in addition to your existing mortgage. It allows you to borrow from your home equity to use toward major, one-time expenses, like a vacation home down payment or college tuition, since you’ll receive a lump sum. Loan terms can last anywhere from five to 30 years, and since it has a fixed interest rate, your monthly payments will stay the same for the life of the loan.
Note that your house is used as collateral, so if you stop making payments, you could lose your house to foreclosure. If that happens, your home equity loan balance is repaid only after the first mortgage has been paid off. This makes home equity loans riskier for lenders because they are second in line for repayment, so home equity loan rates are often higher than purchase mortgage rates.
Pros and cons of a home equity loan
Pros
- You’ll receive a cash lump sum.
- The interest rate will be fixed for the entire loan term.
- Your monthly payments won’t change.
Cons
- You’ll make two monthly payments — your existing mortgage payment and the home equity loan payment.
- You can lose your home if you stop making payments.
- Closing costs can be up to 5% of the loan amount.
- Rates are often a bit higher than HELOC rates.
Should you get a home equity loan?
A home equity loan may make sense if:
- You need money for a single purchase.
- You want predictable monthly payments.
- You can manage two house payments each month.
- You want to leave your first mortgage balance alone.
How does a HELOC work?
With a HELOC, you don’t get a lump sum upfront, like a home equity loan. Instead, you get access to a revolving credit line that functions similarly to a credit card: you make a purchase, pay it off and then the limit resets. You can access the HELOC repeatedly during the “draw period,” which is typically 10 years. HELOC closing costs typically range from 2% to 5% of the total credit line.
Pros and cons of a HELOC
Pros
- You get access to a credit line you can use repeatedly.
- You only pay interest on the amount you use.
- Your interest may be tax deductible in some cases.
- You may be able to make interest-only payments during the draw period.
Cons
- Your interest rate will be variable.
- Your monthly payments can increase at any time.
- You may be tempted to overspend on nonessentials.
Should you get a HELOC?
A HELOC may make sense if:
- You don’t need the funds in a lump sum.
- You want to pay off and reuse your funds as needed.
- You can manage two house payments each month.
- You’re interested in interest-only payments for a set period.
Frequently asked questions
Home equity loan interest may be tax deductible if the funds are used to “buy, build or substantially improve” the property. If you used the loan to pay everyday living expenses, any accrued interest isn’t deductible.
The monthly payment for a $100,000 home equity loan depends on the interest rate and loan term. For example, let’s assume a 6.99% rate and 10-year repayment term. In this case, your monthly payment would be about $1,161.
If a cash-out refinance or HELOC isn’t in the cards, you can consider alternatives like a personal loan. Keep in mind that a personal loan tends to have a higher interest rate than a cash-out refinance or HELOC, but they generally have few to no closing costs. Additionally, you won’t need to put your home up as collateral for most personal loans.
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