Comparing the Home Equity Line of Credit (HELOC) & Cash-Out Refinance

A HELOC (or Home Equity Line of Credit) and Cash-Out Refinance are both ways to access the value that has accumulated in your home.

To determine if you qualify for either option you must first see how much equity you have. The first step is to estimate the value of your home and find out how much you still owe on the mortgage. If the difference between the two is a positive number, that’s the equity you have in the home. Let’s compare both options for taking advantage of your home’s equity.

Start with Your Home’s Equity

Simply put, home equity is the market value of your home. The amount of equity you’ve built throughout the repayment period of your loan is determined by taking the appraised value of your home and subtracting the balance of your loan. The appraised value of the home is determined by a licensed property appraiser and is typically ordered by the lender during the mortgage process.

To get an idea of your property’s value prior to jumping into the mortgage process, search your address in on our easy-to-use home search tool, Xome. Xome provides estimated home values based on property-specific elements in addition to local market conditions and trends.

Building equity happens over time as you pay down the loan, typically through monthly mortgage payments. As you chip away at the principal, your loan-to-value (LTC) ratio decreases, and your equity increases. Other ways to increase the value of your home are through home maintenance, property upkeep, and home improvement projects, including remodels or upgrades.

It’s also important to note that as the housing market changes, your property’s value may change, which in turn can affect the amount of equity you have at the time. For example, when home prices are on the rise, your home equity is likely to increase. If you have any questions, call 888-673-5521 to get in contact with a Loan Professional.

What is a HELOC?

A HELOC not only has an imposing sounding acronym, but it’s also often confused with a cash-out refinance. A HELOC is a form of home equity financing where you borrow against the existing equity in your home.

The money is typically used for large expenses or to consolidate higher-interest rate debt on other loans such as credit cards.

How Does a HELOC Work?

A HELOC works like a credit card in that you have a set amount of money available to borrow and pay back. Similarly, you can take out money when you need it, and you only pay interest on the amount you borrow.

A HELOC is considered a second mortgage and will have its own term and repayment schedule. In many cases, once the loan repayment begins you will have twenty years to repay any outstanding balance.

Loan Terms for a HELOC

As mentioned earlier, with a home equity line of credit (HELOC), you apply for a second mortgage. As its own home loan, it comes with its own unique terms and repayment schedule. It’s separate from your original mortgage loan.

While some HELOCs offer fixed-rate options, HELOCs generally have variable interest rates. While fixed rates are more commonly preferred by borrowers over a rate that changes with market conditions (variable), the good news is, variable rates have rate caps, which limit how much the rate can fluctuate.

Pros and Cons of a HELOC

Pros

• A HELOC often has a lower interest rate than some other common types of loans, and the interest may be tax-deductible.
• In many cases, once the loan repayment begins you will have twenty years to repay any outstanding balance.

Cons

• The rate is adjustable, which means it can increase or decrease according to designated benchmarks. Therefore, your monthly payment may increase or decrease as well.
• You will be making two payments on your house versus one – your existing mortgage and your payment on the HELOC will have its own term and repayment schedule. 

What is a Cash-Out Refinance?

A cash-out refinance replaces an original mortgage with an entirely new loan that's greater than what you currently owe.

How Does a Cash-Out Refinance Work?

The difference between your current loan amount and the new loan amount provides you a "cash out.” Succinctly, you pocket the difference in cash, less any closing costs.

Loan Terms for a Cash-Out Refinance

With a cash-out refinance, you apply for a new loan that replaces your current mortgage. It repays the outstanding balance on your current mortgage with a new loan. Frequently, borrowers experience better rates and/or terms. Because your original loan is paid off in this process, your new loan may be different in terms of the payback period, interest rate, monthly payment amount, and more. The amount of cash you receive at closing in a lump-sum is included in your new loan balance. The amount of cash you choose to extract from your home equity is then included in your new loan balance.

With a cash-out refinance, the interest rate is fixed, meaning your monthly payment is the same throughout the life of the loan.

Pros and Cons of a Cash-Out Refinance

Pros

• Borrowers get a fixed payment over the life of the loan with only one bill. Interest rates are generally lower for cash-out refinances than for HELOCs.
• The flexibility of a cash-out refinance’s lump sum lets you choose how you want to utilize your money. 
• There are multiple types of loans available including flexible terms, and fixed and variable rate options.

Cons

• You will be taking on a new loan with new terms which could extend the length of your mortgage. A cash-out refinance also reduces the equity you have in your home.
• You will have to go through the approval process for a cash-out refinance and will have to meet certain eligibility requirements to gain approval. 
• You may incur closing costs.  

How You’ll Receive Your Funds from a Cash-Out Refinance and a HELOC

HELOC Funds

As a revolving line of credit, a HELOC gives a borrower access to money during the initial draw period of the loan, which is typically the first 10 years of the loan term. After the draw period, you begin paying back the loan, including interest, and no longer can withdraw money. HELOCs work well for borrowers who want access to cash in various sums rather than all at once.

Cash-Out Funds

A cash-out refinance is a good option for borrowers looking to refinance for a lower rate and receive a lump-sum of cash at once. With a cash-out, you receive cash in the form of a check at closing.

Is a Cash-Out Refinance Better than a HELOC?

Both options can be used to fund home improvements or get rid of high-interest debt. In review, the difference between a cash-out refinance and a HELOC is that the former pays off an existing first mortgage while the latter is taken out in addition to a mortgage. With a cash-out refinance you replace your existing mortgage with a new home loan, while with a HELOC you secure access to credit against your current equity.

A HELOC might make more sense if you want to delay payment and draw from the loan amount as needed over the course of ten years whereas with a cash-out refinance you would get immediate access to cash at a lower cost to borrow.

Need some help deciding which option might be right for you? We’re happy to help! Call 888-673-5521 to speak with one of our mortgage consultants about a mortgage option that works for you.  

*https://www.corelogic.com/intelligence/home-equity-gains-reached-new-highs-in-2021/

Disclaimer: by refinancing the existing loan, the total finance charges may be higher over the life of the loan.