Homeowners who are looking to tap into their home equity have two popular options: a cash-out refinance and a Home Equity Line of Credit (HELOC). While both options allow homeowners to access the equity in their home, there are key differences between the two that should be considered before making a decision.
Cash-out Refinance
A cash-out refinance involves refinancing the existing mortgage on a home and taking out additional funds in cash. The new mortgage replaces the old one, with the additional funds added to the new loan balance. Homeowners can use the funds from a cash-out refinance for a variety of purposes, including debt consolidation, home improvements, or even starting a business.
The amount of equity that can be accessed through a cash-out refinance is typically limited to a maximum of 80% of the home’s value. For example, if a home is worth $500,000 and the current mortgage balance is $300,000, the maximum amount that can be borrowed through a cash-out refinance is $200,000.
HELOC
A Home Equity Line of Credit (HELOC) is a revolving line of credit that allows homeowners to access their home equity as needed. With a HELOC, homeowners are given a credit limit based on the equity in their home. They can draw on this line of credit as needed, making payments only on the amount borrowed.
Unlike a cash-out refinance, a HELOC does not replace the existing mortgage on the home. Instead, it is a separate loan with its own terms and interest rate. Homeowners can use the funds from a HELOC for a variety of purposes, including home improvements, education expenses, or even a down payment on a second home.
The amount of equity that can be accessed through a HELOC is typically limited to a maximum of 90% of the home’s value. For example, if a home is worth $500,000 and the current mortgage balance is $300,000, the maximum amount that can be borrowed through a HELOC is $150,000.
Key Differences Between Cash-out Refinance and HELOC
- Interest Rates: A cash-out refinance generally comes with a lower interest rate than a HELOC. This is because a cash-out refinance is a first mortgage, whereas a HELOC is a second mortgage. As a result, cash-out refinance rates are typically lower than HELOC rates.
- Repayment Terms: A cash-out refinance typically comes with a fixed interest rate and a fixed term, usually ranging from 15 to 30 years. A HELOC, on the other hand, typically comes with an adjustable interest rate and a draw period of 10 years, followed by a repayment period of 10 to 20 years.
- Payment Structure: With a cash-out refinance, homeowners make one monthly payment that includes both the new mortgage and the additional funds borrowed. With a HELOC, homeowners make monthly payments only on the amount borrowed, with the option to pay down the balance and borrow again.
- Closing Costs: A cash-out refinance typically comes with higher closing costs than a HELOC. This is because a cash-out refinance is a new mortgage, whereas a HELOC is an additional loan on top of the existing mortgage.
Which Option is Right for You?
One of the main benefits of a cash-out refinance is that it can provide a lump sum of cash that can be used for any purpose. This can be especially helpful if the homeowner needs a large amount of cash upfront for a specific expense, such as a home renovation or debt consolidation. In addition, a cash-out refinance typically has a fixed interest rate, which means that the borrower’s monthly payment stays the same over the life of the loan.
However, there are also drawbacks to consider. A cash-out refinance typically comes with higher closing costs than a HELOC, and the borrower will need to pay interest on the entire loan amount, including the cash-out portion. In addition, if the homeowner has already paid off a significant portion of their mortgage, a cash-out refinance could reset the clock and extend the life of the loan.
Benefits and Drawbacks of HELOC
One of the main benefits of a HELOC is its flexibility. Unlike a cash-out refinance, a HELOC allows the borrower to draw funds as needed, which can be helpful for ongoing expenses such as home repairs or college tuition. In addition, the interest rate on a HELOC is typically lower than the interest rate on a cash-out refinance, which can save the borrower money in interest charges over the life of the loan.
However, there are also drawbacks to consider. The interest rate on a HELOC is typically variable, which means that it can go up or down over time. This can make it difficult for borrowers to budget their monthly payments. In addition, a HELOC does not provide a lump sum of cash upfront, which may not be ideal for borrowers who need a large amount of money immediately.
Which Option is Best for You?
If you are a homeowner in need of funds, you may be considering a cash-out refinance or a home equity line of credit (HELOC). While both options involve using your home’s equity, they have significant differences in terms of how they work and their benefits and drawbacks. In this article, we’ll take a closer look at cash-out refinancing versus HELOCs and help you decide which option is best for your needs.
What is a Cash-Out Refinance?
Differences between Cash-Out Refinance and HELOC
One of the biggest differences between a cash-out refinance and a HELOC is how the loan is structured. A cash-out refinance replaces the existing mortgage, whereas a HELOC is a separate loan that runs alongside the existing mortgage. This means that a cash-out refinance has a fixed interest rate and term, while a HELOC typically has a variable interest rate and no fixed term.
Another key difference between the two options is the way the funds are accessed. With a cash-out refinance, the borrower receives the funds in a lump sum at closing. In contrast, a HELOC allows the borrower to draw funds as needed over time, up to the credit limit.
Benefits and Drawbacks of Cash-Out Refinance
One of the main benefits of a cash-out refinance is that it can provide a lump sum of cash that can be used for any purpose. This can be especially helpful if the homeowner needs a large amount of cash upfront for a specific expense, such as a home renovation or debt consolidation. In addition, a cash-out refinance typically has a fixed interest rate, which means that the borrower’s monthly payment stays the same over the life of the loan.
However, there are also drawbacks to consider. A cash-out refinance typically comes with higher closing costs than a HELOC, and the borrower will need to pay interest on the entire loan amount, including the cash-out portion. In addition, if the homeowner has already paid off a significant portion of their mortgage, a cash-out refinance could reset the clock and extend the life of the loan.
Benefits and Drawbacks of HELOC
One of the main benefits of a HELOC is its flexibility. Unlike a cash-out refinance, a HELOC allows the borrower to draw funds as needed, which can be helpful for ongoing expenses such as home repairs or college tuition. In addition, the interest rate on a HELOC is typically lower than the interest rate on a cash-out refinance, which can save the borrower money in interest charges over the life of the loan.
However, there are also drawbacks to consider. The interest rate on a HELOC is typically variable, which means that it can go up or down over time. This can make it difficult for borrowers to budget their monthly payments. In addition, a HELOC does not provide a lump sum of cash upfront, which may not be ideal for borrowers who need a large amount of money immediately.
Which Option is Best for You?
