HELOC vs Cash-Out Refinance: Which One is Better in 4 Situations

The problem: you need cash but most of your net worth is tied up in home equity.

You could either get a HELOC or a full cash-out refinance. But which one is better long term? Are both bad ideas? Let’s find out.

HELOC vs Cash-Out Refinance

First, some definitions:

HELOC: Home Equity Line of Credit. A variable-rate credit line that sits on top of your existing first mortgage.

Cash-out refinance: You open a bigger mortgage than you owe. It pays off your existing loan and you get the difference in cash.

Which one you choose depends on your situation.

Rules of thumb:

Generally, getting a cash-out refinance makes more sense if you want a large amount of cash and mortgage rates are the same or lower than your existing mortgage.

A HELOC is better when you need a smaller amount or just need it temporarily. These are also popular when someone doesn’t want to lose their first mortgage rate.

A third option -- the home equity loan -- is a hybrid of the two. It's a fixed loan that doesn't affect your existing first mortgage.

HELOC Advantages

• Does not affect your first mortgage

• Low closing costs

• Access up to 100% of your home equity

• Pay down and re-borrow as needed

• You do not have to draw any money until you need it

• Faster closing

HELOC Drawbacks

• Variable interest rate

• Refinancing the primary mortgage later can be difficult

• Easy access to funds could lead to a large debt burden

Cash-Out Refinance Advantages

• Get a large amount of cash at a relatively low rate

• Rate and payment is fixed

• Potential to improve the terms on your existing first mortgage

• Only one payment each month

Cash-Out Refinance Drawbacks

• High closing costs

• You lose your existing first mortgage rate

• You start over with a 30-year mortgage unless you refinance into a shorter term

Situational Comparisons

Which loan product you choose depends on the purpose. Here’s when you might use each loan in various situations.

HELOC vs Cash-Out Refinance for Renovation

A HELOC is better for small renovations or ones where you are unsure of the cost or your start date. You can open up a HELOC and use $0 to begin. You do not pay interest until you draw funds. Only draw what you need to keep costs down.

If you need $100,000 or $200,000 or more, a cash-out refinance may be better. HELOC rates are high and that would mean a large payment. But proceed with caution if you’ll lose your first mortgage rate in the process.

HELOC vs Cash-Out to Buy Another Home Before You Sell

Neither a HELOC nor a cash-out refinance is ideal if you plan to sell the home soon and you need short-term funds for a down payment. You could open up a HELOC then pay it off weeks or months later, but lenders frown on this.

Instead, try a bridge loan. Some companies offer bridge financing if you use them for the new loan.

HELOC vs Cash-Out to Buy Additional Real Estate

A cash-out refinance might be better if you need down payment funds for a second home or investment property.

It’s risky to take out a large variable-rate HELOC. However, you could consider a home equity loan – a fixed second mortgage that doesn’t affect your first mortgage.

HELOC vs Cash-Out for Debt Consolidation

Many people have student loans, auto loans, and credit card debt. Some of this debt has very high interest rates.

For example, you are probably paying at least $5,000 per year in interest if you have $20,000 in credit card debt.

A cash-out refinance might be better to consolidate debt. A HELOC is open-ended like a credit card. You can continue to borrow, putting yourself in a worse position than before.

A cash-out refinance can pay off all your debt at closing with lump-sum payments to each company without you ever seeing the money. There’s no temptation to borrow more.

Apply for a Cash-Out Refinance or HELOC

As rates drop, you might find that you can get a cash-out refinance at a similar or lower rate than your current mortgage. If you can drop your rate and access home equity, a cash-out refinance is a smart move.

But get advice from a professional. A HELOC might serve your needs just fine without replacing your primary mortgage.