Key takeaways:
- Cash-out refinances replace your existing mortgage and pay you out the difference in cash.
- HELOCs give you access to a revolving line of credit, similar to a credit card, for a set period of time.
- Which option is best for you depends on factors like what you need the funds for and when you plan to use the money.
There are many reasons you might need to tap into the equity you’ve built in your home, such as an emergency home repair or to pay for college tuition. Two of the most popular methods to access your home equity are a cash-out refinance and a home equity line of credit (HELOC). Both these options have upsides and drawbacks, so carefully consideri which one is best for your situation.
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What is a cash-out refinance?
A cash-out refinance is a type of mortgage loan that replaces your existing home loan with a larger one and pays you the difference in one lump sum. For example, if you need to borrow $50,000 and you have a current mortgage of $200,000, you’d need to take out a $250,000 cash-out refinance loan. However, it is possible to get a cash-out refinance on a paid-off home.
Note:
Cash-out refinance loans can be used to cover almost any expense, including home improvements and consolidating debt.
What is a HELOC?
A HELOC is a common financing method that lets you leverage your home equity for cash.
Unlike traditional home loans, HELOCs offer a revolving line of credit you can spend from as needed over a set draw period, up to a predetermined limit. During this time, you’ll typically only be responsible for interest payments, but this varies from lender to lender.
After the draw period, you’ll no longer be able to use your credit line and must repay what you borrowed on your credit line plus interest.
Note:
Since HELOCs use your home as collateral, it’s important to remember that if you fail to repay your loan you might face foreclosure.
How do cash-out refinances and HELOCs differ?
Although cash-out refinances and HELOCs can be used to access your home equity, they have many differences. A cash-out refinance is paid out in one lump sum while a HELOC gives you access to a revolving line of credit that you can pull from as needed.
Here are some of the most important features of cash-out refinances and HELOCs:
Pros and cons of cash-out refinance
When considering if a cash-out refinance is for you, it’s important to keep these pros and cons in mind:
Pros of cash-out refinance
- Lump sum payout: Cash-out refinance are paid out to you in one large lump sum, making them ideal if you need a large amount of cash to cover an expense.
- Fixed monthly payments: Most cash-out refinances come with fixed interest rates that result in predictable monthly payments.
- Repayment terms up to 30 years: Cash-out refinances often come with repayment terms up to 30 years, letting you spread out your payments over a long period of time.
- Possible tax benefits: If you use your cash-out refinance to pay for home improvements you might be able to deduct your interest payments.
Cons of cash-out refinance
- Increased debt burden: Cash-out refinances replace your original mortgage loan, meaning you’ll owe more on your mortgage than before and extend the amount of time it takes to repay your mortgage.
- You’ll pay closing costs: Cash-out refinances come with closing costs that amount to approximately 2% to 5% of the loan cost.
- Foreclosure risk: Since they are secured by your home, if you don’t repay your cash-out refinance loan you risk having your home foreclosed on.
Pros and cons of HELOCs
Getting a HELOC is a big financial move. Before you do it, consider these pros and cons carefully:
Pros of HELOCs
- Borrow as needed: During the draw period, which typically lasts 10 months, you can access your HELOC funds as needed.
- Interest-only payments during draw period: During the draw period, many HELOC lenders only require you to pay the cost of accrued interest.
- Potential tax benefits: If you use your HELOC to pay for home improvement expenses, you might be able to deduct the interest you paid on your taxes.
- Separate from your mortgage: HELOCs are taken out in addition to your mortgage. This is helpful if you have a low rate because you won’t replace it, like you would with a cash-out refinance.
- Lower closing costs: HELOCs typically have lower closing costs than cash-out refinance loans.
Cons of HELOCs
- Variable interest rates: HELOCs often come with variable rates, making monthly payments less predictable.
- Equity requirements: To get a HELOC you’ll need to own more equity than you want to borrow against, limiting how much you can borrow.
- Foreclosure risk: HELOCs are secured by your home, so you’ll be at risk of losing your home to foreclosure if you fail to repay your loan.
When should you choose a cash-out refinance or HELOC?
Whether a cash-out refinance or a HELOC is best for you depends on how you plan to spend the money and how much equity you’ve built in your home. If you have a large one-time expense to cover, a cash-out refinance might be the better option for you. On the other hand, if you need funds to cover a project with an extended timeline that requires multiple purchases, a HELOC may be a better choice.
You’ll also want to consider which option best fits your budget. “In both cases, the repayment terms and interest rate dictate what your monthly payments will be,” says Omer Reiner, a licensed REALTOR® in Florida. “Keep in mind that [with a HELOC] you will still be paying offn your original home loan if you have a balance on that, so weigh that debt against how much you borrow against the equity.”
Cash-out refinance vs. HELOC FAQ
Is a cash-out refinance better than a HELOC?
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Can you use a HELOC to pay off a cash-out refinance?
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Which option is better for home renovations?
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How do interest rates compare between a cash-out refinance and a HELOC?
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Are there any tax benefits for either option?
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