HELOC vs. cash-out refinance: What's the difference?
Most homeowners have gained a serious amount of equity in the last few years. In fact, the average homeowner now has over $274,000 in equity according to a recent report by CoreLogic.
That's a good thing — especially with inflation high and a possible recession on the horizon, an increased amount of equity allows you to tap into that value to access money when you need. With home equity on your side, you can consider products like home equity lines of credit (HELOCs) or cash-out refinancing, both of which offer cash in a pinch.
Are you considering borrowing against your home equity? Here's what to know about HELOCs and cash-out refinances.
Start here by comparing home equity rates you can qualify for today.
What is a HELOC?
A HELOC is a line of credit based on your home equity. You can withdraw money from it as needed for an extended period of time — usually up to 10 years. During that period, you typically are only required to pay interest on what you've taken out.
Once that initial draw period ends, you'll start repaying what you borrowed either in monthly payments or in a lump-sum balloon payment.
"I recommend clients go with a HELOC when they are looking for flexibility and they have fluctuating borrowing needs such as funding home renovations, education expenses, or projects with costs spread over time," says Carolina Gerdts, executive vice president at RelatedISG Realty. "I've had clients using HELOCs to offer a down payment on their next home, which helped them become landlords while renting out their first property."
It's important to note that HELOCs typically have variable interest rates, so the rate you're paying will change monthly and fluctuate as the broader rate environment changes.
"That means if interest rates go up substantially, as they have in the last year, your monthly payment could increase and notably impact your budget," says Ryan Shuchman, partner at Cornerstone Financial Services.
Learn about HELOC rates available to you right now here!
What is cash-out refinancing?
Cash-out refinancing is when you replace your current mortgage loan with a new one that has a larger balance than you owe. The new loan pays off the old one, and you get the difference between the two back in cash.
With cash-out mortgage refinancing, you'll receive a lump sum you can use for anything you like and pay it back as part of your monthly mortgage payments.
"Cash-out refinancing can be the solution when you require an immediate lump sum of cash for specific expenses, such as consolidating high-interest debt, making a necessary purchase, or covering high unexpected medical costs," Gerdts says.
However, because cash-out refinancing adds to your mortgage balance, it can often mean higher monthly payments. Because you're refinancing, you'll also lose your current mortgage rate — which is something to consider if you locked in a very low rate in the past few years.
How are HELOCs and cash-out refinancing alike?
HELOCs and cash-out refinances both let you borrow from your home equity. They also come with no limits to how you can use the funds, and they can give you extended periods to pay off your balance (usually up to 30 years).
With both products, you may be eligible for a tax deduction as long as you use the funds to buy, build, or substantially improve your home, according to the IRS.
How are HELOCs and cash-out refinancing different?
That's about where the similarities end, as HELOCs and cash-out refinances are really quite different. For one, HELOCs come with more flexibility over a longer term.
"The HELOC allows you to borrow, pay back, and borrow again as many times as you wish," Shuchman says. "A cash-out refinance involves borrowing a fixed amount, which you can pay back early if desired, but doesn't allow for additional borrowing without a subsequent full refinancing process."
The two also differ in interest rates. HELOCs almost always come with a variable interest rate, which can make your payments fluctuate over time. Cash-out refinancing can be done with either a variable or fixed interest rate (the most common option).
Finally, how they interact with your main mortgage loan differs. With a cash-out refinance, you replace your current loan altogether. HELOCs, on the other hand, are a type of second loan — one that's in addition to your existing mortgage. That means you'll have two payments each month instead of one.
Other home equity alternatives
These aren't your only options if you want to tap your home equity.
Home equity loans are another possibility you can explore. These loans are a type of second mortgage. Similar to a cash-out refinance, you'll get a lump sum payment, and you repay the balance monthly over 10 to 30 years. These usually have fixed interest rates.
Reverse mortgages are another option for homeowners aged 62 or older. If you've paid off or nearly paid your mortgage, you can access your home equity either through a lump sum or monthly payment. You'll only be responsible for repaying the equity once you sell your home, move out or pass away.
Compare rates today to find the best way to access your home equity right now!
