HELOC vs. Cash-Out Refinance: What’s the Difference?

Choose between a revolving line of credit and a lump-sum payment

Couple discussing contract terms during meeting with mortgage lender
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If you have enough equity in your home, you may be able to access some of it and get cash. Two possible ways to do that are through a home equity line of credit (HELOC) or a cash-out refinance. 

But while both loan options are secured by your home equity, they differ in many ways. Understanding the differences between a HELOC vs. cash-out refinance can help you determine which is the better option for you.

What’s the Difference Between a HELOC and a Cash-Out Refinance?

HELOC Cash-Out Refinance
Acts as a second mortgage Replaces your existing mortgage
Higher, variable interest rates Lower, fixed or variable interest rates
Provides a revolving line of credit you can use over and over again Provides a lump-sum payment
More difficult to qualify for Easier to qualify for
Typically charges lower closing costs Typically charges higher closing costs

How They Work

A HELOC is a second-mortgage loan, which means that it exists in addition to your original mortgage loan, instead of replacing it.

HELOCs are revolving lines of credit, which means they work similarly to credit cards. You'll receive a credit limit and can borrow up to that amount, pay it off, and use it again throughout the loan's draw period. 

For example, if you have a $50,000 HELOC and take a draw of $20,000, you still have $30,000 in available credit. If you pay back $10,000 of what you borrowed, you now have $40,000 in available credit.

In contrast, a cash-out refinance replaces your original mortgage loan, so it's a first-mortgage loan. Instead of a revolving line of credit, a cash-out refinance provides a lump-sum payment of the difference between your original loan balance and the new one. 

For example, if you're refinancing a $200,000 loan with a $250,000 loan, you'll receive a $50,000 check. 

Repayment Terms

HELOCs typically have a draw period and a repayment period. During the draw period, which usually lasts five to 10 years, you can take withdrawals from your available credit. While you can pay off what you borrow and take further withdrawals, you're typically only required to pay interest on your balance.  

Once the repayment period starts, your balance will be amortized, and you'll make regular monthly payments, generally for 10 to 20 years. Because HELOCs usually have variable interest rates, your monthly payment may fluctuate throughout the repayment period. However, some lenders allow you to lock in a fixed rate on your balance.

With a cash-out refinance, you'll make monthly payments just like you did with your original mortgage loan. The only difference is that your new payments will be higher because of the increased loan amount.

Costs

A cash-out refinance loan typically carries a lower interest rate than a HELOC because of the way the loans are positioned. With a HELOC, the lender has a secondary claim that’s behind the lender that holds the mortgage. If you default, the primary mortgage lender gets its money back before the HELOC lender does.

As a result, HELOC lenders typically charge higher interest rates to account for that risk. For that same reason, they're also generally more difficult to qualify for than a cash-out refinance loan.

That said, HELOCs typically charge lower closing costs. With a cash-out refinance, closing costs can range from 3% to 6% of the loan amount, which includes the original mortgage balance plus the amount you're taking out in cash. HELOCs charge between 2% and 5% of the credit limit, but the loan amount is often much lower, leading to lower costs. Some HELOC lenders don't charge closing costs at all.

As you compare HELOCs, watch out for annual fees that can increase your costs. 

Loan Amounts

Mortgage lenders typically determine how much you can borrow with a cash-out refinance or HELOC based on the amount of equity you have in your home. 

With a cash-out refinance, you're typically limited to a loan-to-value (LTV) ratio of 80%, which means your original loan balance and the amount you want in cash can't combine to be more than 80% of the value of the home. One major exception to this rule is if you qualify for a VA refinance loan, which may allow you to borrow up to 100% of your home.

While many HELOC lenders also limit your combined LTV to 80%, some may go as high as 100%.

Which Is Right for You?

It's important to consider your current situation and your goals to determine whether a HELOC or cash-out refinance loan is a better solution for you. 

For example, a HELOC may be better for you if you don't necessarily need the full amount you qualify for right now but want the option to take draws when you need them. The lower closing costs and interest-only payments during the draw period can also be beneficial if you can't afford to pay a lot upfront. 

Conversely, a cash-out refinance could be a solid choice if you're not concerned about the higher closing costs and simply want a lower, fixed interest rate. It may also be the better option if you want the full amount upfront and don't have any need to take multiple withdrawals over a long period. Finally, a cash-out refinance may be better if your credit history doesn't quite meet the standards of a HELOC but is good enough to qualify for a refinance loan.

If you don't want to refinance your original loan but also don't want a revolving line of credit, you may consider a home equity loan instead.

The Bottom Line

If you're hoping to tap some of your home equity, there are a few ways to do it, including through a cash-out refinance or a HELOC. Research how the eligibility requirements, costs, and repayment processes can vary between a cash-out refinance and a HELOC to determine the right option for you.

Additionally, consider a home equity loan and how it compares with cash-out refinancing or using a HELOC. The important thing is that you do your due diligence to find the loan option that best meets your needs. 

Frequently Asked Questions (FAQs)

Is it easier to qualify for a HELOC or a cash-out refinance?

It's generally easier to qualify for a cash-out refinance than a HELOC. This is primarily because HELOCs pose a greater risk to lenders than cash-out refinancing because of their secondary position in the event of a default. As a result, they generally charge higher interest rates and have higher creditworthiness requirements.

Is interest on a HELOC tax-deductible?

Interest on a HELOC is tax-deductible only if you use the funds to buy, build, or substantially improve the home that you used to secure the loan. So if you're making home renovations with that money, it may be tax-deductible up to a set limit. But if you're using it to consolidate other debt or for other reasons, it's generally not. Consult a tax professional for your particular situation.

Is interest on a cash-out refinance tax-deductible?

As always, the interest you pay on the balance from your original mortgage loan is tax-deductible up to a set limit. But on the portion of the new loan that you received in cash, you can only deduct the interest you pay if you use the funds to make capital improvements to your home that increase its value. If you use the money for other purposes, interest is generally not deductible.

How do you pay back a HELOC?

Repayment terms can vary from lender to lender. In most cases, though, you'll pay just interest-only payments during the HELOC's draw period. Once that period ends, the lender will amortize your balance over a set repayment term, and you'll make regular payments based on that schedule.  

How do you pay back a cash-out refinance?

Cash-out refinance loans work like traditional mortgage loans, which means you'll pay them back the same way. The loan amount, which includes the original loan balance and the cash amount, is amortized over the loan's term—say 15 or 30 years—and you'll make regular monthly payments based on that schedule.