Comparing Your Options: Cash-Out Refi Vs. HELOC


It Depends On Your Ultimate Goal

Vanilla or chocolate? Plain or peanut? Unless you have a food allergy, these options are fundamentally equal, and you will base your selection on personal preference. We can say the same of a cash-out refinance or home equity line of credit (HELOC). Both are viable ways to access home equity, and each technique comes with assorted pros and cons. Whether you choose one or the other will depend on your ultimate goal.

SEE ALSO: Is Your Property at Risk With a HELOC?

Cash-Out Refinance

You might choose a cash-out refinance to replace your current mortgage, if you can get a lower interest rate. You will also get a higher new balance, because you will be adding cash to the amount of principal still remaining on your loan. If you choose a cash-out refinance, you’ll reset your loan term. Most lenders require you to maintain at least 20 percent equity in your home, which limits the amount you can borrow. If you currently owe $100,000 on your mortgage, for example, and your home appraised for $180,000, the maximum amount you can borrow is $144,000. At closing, you can receive up to $44,000 in cash after paying off your balance. Cash-out refinance pros include:
  • Reducing interest rate on entire balance
  • Lower interest rate than a HELOC
  • Fixed interest rate, if you choose
  • Easier to get approval (provided you have plenty of equity in your home)
  • Access to a lump sum of cash
  • Single monthly mortgage payment
Cash-out refinance cons include:
  • Resetting loan term
  • Closing costs

Home Equity Line of Credit

A HELOC is a second mortgage that leaves your first loan intact. It enables you to access home equity through a line of credit. You can use the funds when you wish and in any manner you chose, up to the credit limit during the loan’s draw period. Just like a cash-out refinance, most lenders will require you to maintain at least 20 percent equity in your home. As in our previous example, if you owe $100,000 on a property that appraises for $180,000, your lender may approve you for a HELOC of $44,000. However, unlike a cash-out refinance, you don’t have to use the full amount. You could draw $10,000 here, and $5,000 there, and only pay interest on the $15,000 you’ve borrowed. HELOC pros include:
  • Little to no closing costs
  • Access cash as you need it
  • Only pay interest on what you draw
HELOC cons include:
  • Higher interest rate than a cash-out refinance
  • Variable interest rate
  • Monthly payment in addition to your first mortgage

SEE ALSO: Renovation Financing: Home Equity Loan Vs. 401(k)

Other Considerations

Of course, you have to consider your ultimate goal, in addition to interest rates and closing costs. A cash-out refinance is best when you want to lower your monthly mortgage payment, as well as access equity. Because it has a lower interest rate, a cash-out refinance may also be preferable for one-time investments, such as replacing your roof, building an addition on your home, or buying a real estate investment property. On the other hand, if you are 20 years into a 30-year mortgage, you may not want to reset your loan term with a cash-out refinance, making a HELOC the better option. Because you pay interest only on the equity you actually draw, a home equity line of credit may also be preferable for ongoing expenses such as medical care, tuition, or a string of home improvements.
Date of original publication:
Updated on: November 10, 2015

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