Cash out refinancing vs. HELOC: Which should you choose?

  • Cashing in on a refinance involves replacing your existing mortgage with a new one.
  • A HELOC is a credit card-like secondary mortgage that allows you to withdraw funds as needed.
  • Either option can turn your home equity into cash if you get the right rate.

When your home’s value rises, it can be a smart financial move to take advantage of the increased equity. You can use the money to get out of high-interest debt, pay for renovations and repairs, or just about any other purpose you can imagine.

Cash-out refinancing and home equity lines of credit (HELOCs) are one of the most popular mechanisms for taking this asset and turning it into cash.

Cashing in on Refinances and Home Equity Lines of Credit: At a Glance

While both cash-out refinancing and HELOCs can help you gain home equity, there are some important differences between them to understand.

  • cash refinancing is when you replace your existing mortgage with a new, larger mortgage. The new loan pays off the old loan, and you can return the difference between these two balances in cash.
  • a HELOC is a secondary mortgage. It uses your equity as collateral and you get a line of credit that can be drawn over a set period of time (usually 10 years). It works much like a credit card, usually with an adjustable interest rate.

Homeowners can use either option to access the equity they’ve built in their home, often with lower interest rates than other forms of credit such as credit cards, said Steve Kaminsky, head of U.S. home loans at TD Bank.

“Cash refinance mortgage transactions typically require higher

settlement cost

“The HELOC adds a second loan, so the borrower will need to manage two payments instead of one,” Kaminski said.

What is a cash refinance?

With cash-out refinancing, you can replace your current mortgage with a new, larger mortgage. The new loan pays off the old loan and you will receive cash back for the difference between the two balances.

“Cash refinancing allows homeowners with partial home equity to purchase a new mortgage at a higher price than their existing mortgage and pocket the difference in cash – minus transaction costs,” said Rob Heck, vice president of Morty’s Mortgage loan.

Cashing in on a refinance can be a good option if your mortgage rate is low, as it allows you to replace your existing mortgage with a lower-rate mortgage. It’s also a smart option if you want to consolidate high-interest debt like credit cards, or if you have fixed costs that you need to pay. (Cash refinancing comes with a one-time payment, while a HELOC allows you to withdraw funds as needed.)

If you have to trade lower rates for higher rates, or if you’re struggling financially, it may not be wise to cash out and refinance.

“With cash-out refinancing, your payments may increase significantly, depending on the market rate and the increase in the loan amount,” Kaminsky said. “When home values ​​are rising and mortgage rates are low, cashing in on refinancing is often a good option.”

The pros and cons of cashing in on refinancing

Cash Refinancing Example

Here’s how a typical cash-out refinancing works:

Let’s say your existing mortgage balance is $200,000 and your home is worth $400,000. If you need cash, you can get a $300,000 loan with cash refinancing. Then, $200,000 of that will be used to pay off your old mortgage, and you’ll get the remaining $100,000 in cash.

What is a HELOC?

HELOCs work much like credit cards. You can access a revolving line of credit based on how much equity you own, and you can draw on that line of credit as needed for the first 10 years. This is called the draw period. You only pay interest on the balance used during this period.

“Unlike a cash refinance, a home equity loan doesn’t replace your first mortgage,” Heck said. “Instead, you get a second mortgage with a higher interest rate.”

Once the initial 10-year term is over, you will need to pay off the balance in one lump sum or monthly installments (this will depend on your lender and the terms of the HELOC). HELOCs typically have variable interest rates, which means your interest rates and payments may fluctuate over time.

“HELOCs can provide greater flexibility in managing the equity of a borrowed home,” Kaminski said. “It works a lot like a credit card, as a revolving line of credit that you can use as needed, but the amount can be much larger. This is very useful when managing

home renovation

Projects that need to be funded over time rather than all at once. “

HELOCs also generally cost less to close than a cash refinance, and can settle faster, meaning you can start using your funds sooner. Also, you only pay interest on the funds you use, not the entire line of credit.

“A HELOC is like a credit card that doesn’t pay interest until you spend it, and cash refinancing is like getting a cash advance,” said Jodi Hall, president of Nationwide Mortgage Bankers. “As soon as the money comes in, you pay interest.”

One of the big downsides of a HELOC is that it’s a second mortgage—meaning you’ll be making an additional payment on top of your existing mortgage. Your payments may also fluctuate.

“HELOC is based on variable interest rates and

prime rate

— as the prime rate increases, it may increase in the future,” Kaminsky said.

Advantages and disadvantages of HELOCs

HELOC example

Let’s take a look at a potential HELOC scenario:

Let’s say your existing mortgage balance is $200,000 and your home is worth $400,000. Since most lenders allow you to borrow up to 85% of your home’s value, you can get $140,000 with a HELOC (0.80 x 400,000 – 200,000).

Once approved for a $140,000 HELOC, you’ll get a checkbook or debit card that you can use to withdraw money from your line of credit. You can withdraw funds as needed during the first 10 years of the loan, and you only pay interest on the funds withdrawn during that period. When the initial 10-year term expires, you will pay the principal and interest monthly until the balance is paid off. (You usually have 20 years to repay).

Consult a professional

The choice between a HELOC and a cash refinance is not always clear. If you’re not sure which one will best meet your needs as a homeowner, consult a mortgage professional or tax advisor for guidance.

Whichever method you choose, be sure to shop around to get a loan. Rates and terms can vary widely from one lender to the next, so getting at least some quotes can help you get the best deal.

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