The wonderful thing about homeownership is that it allows flexibility when meeting various financial goals. When you’ve built up equity, you can use either a cash-out refinance or a home equity line of credit, also known as a HELOC, to tap into that money supply, depending on your goals and circumstances.
What’s the difference between a cash-out refinance vs. HELOC? Which is the right path to meet your needs?
Understanding a cash-out refinance
A cash-out refinance replaces your current home mortgage with a new, larger one, giving you access to the home equity you’ve built since you first purchased your home. While standard refinances simply renegotiate the payment terms of the existing loan, cash-out refinances allow homeowners to tap into their home’s equity.
In most cases, people consider a cash-out refinance when the new mortgage terms work for their current circumstances. The extended terms may help them lower interest rates, reduce their monthly payments or remove or add borrowers, with the end result ultimately giving them a cash payout. People typically use this for big expenses, such as major home renovations, education, medical payments or to consolidate debt.
A cash-out refinance will result in less equity in your home, which also means the lender will be taking on greater risk. Depending on how much cash you take, additional costs, fees or higher interest rates could be required to take on the added burden. Most lenders limit how much money a borrower can cash out, typically to 80% of the home’s available equity.
Understanding a home equity line of credit
On the other hand, a HELOC gives you a revolving credit line for large expenses or consolidating debt, allowing you to borrow against the available equity in your home. When you are approved for a HELOC, a certain dollar amount is made available to you. You can borrow as little or as much of this amount as you need it. If you repay any of the balance, you can borrow it again. In that aspect, it works similarly to a credit card, giving you access to funding when you need it most.
HELOC loans are set up with a draw period, typically around 10 years. This means the funding is available to you for the draw period to use as much or as little as you need. At the end of the draw period, repayment begins, and the ability to draw more cash out shuts down.
Which is better – cash-out refinance vs. HELOC?
When you compare cash-out refinance vs. HELOC, it’s easy to see the benefits of each. Both are excellent tools to help you meet your financial goals. When trying to decide which is better for your situation, it helps to answer a few questions first.
What is the money for?
Most people look to both cash-out refinance and HELOCs for help with major expenses that pop up in their lives.
Are you facing an immediate expense? Is it a one-time necessity? Homeowners often face large expenses that need to be paid immediately, such as replacing the roof or renovating the kitchen. These are generally a one-time expense with a lump sum payment. A cash-out refinance is a great option to help you meet sudden or immediate needs.
Will you need money over an extended period of time? Will the amount of funding you need fluctuate? This could be to help your child finance college or to help you deal with ongoing medical expenditures. A HELOC can give you flexibility with the money you take out.
How favorable is your current mortgage?
Cash-out refinances and HELOCs provide different end results.
Are you satisfied with the terms of your current mortgage? If you are interested in adjusting the terms of your loan, a cash-out refinance may be a good option for you. This process involves paying off your old mortgage and setting up a new one with different terms, such as a different interest rate, loan term or type of rate (fixed or adjustable). This can be a good option for homeowners who want to secure more favorable loan terms. Is your current mortgage in a good position? Do you have a great interest rate? Are you comfortable with the existing payment? In this case, a HELOC can give you access to your home’s equity while leaving your current terms alone. Note that you’ll be subjected to new interest rates and loan terms based on the money you withdraw. Once paid off, you’ll still have your original loan in place.
How much money do you need?
Cash-out refinances and HELOCs have different cash-out limits.
For a cash-out refinance, lenders typically allow you to borrow up to 80% of the home’s equity. With a HELOC, that amount could be higher, with many lenders allowing you to borrow up to 85%. At Solarity, you can access up to 95% of your home's equity.
Remember, with a HELOC, you’ll have an additional monthly payment. Cash-out refinances bundle everything into one payment, whereas HELOCs establish a new loan on top of your existing mortgage.
Are you ready to explore your options?
Whether you know which loan type would work best for your situation or want to explore your options a bit further, we're here to help! Get in touch with us to get all of your questions answered immediately. We can help you decide which option might work best for your situation.