What Is a HELOC vs Cash Out Refi?

A HELOC and cash out refinance are two ways to use your home’s equity. They both turn your equity into cash, but in different ways. With a HELOC, you get a separate mortgage. That means two mortgage payments. But a cash-out refinance replaces your first mortgage, leaving you with one mortgage and one payment each month. Which refinance option is right for you? Read on us to help you find the best solution.

HELOC vs Cash Out Refi: The Role of Home Equity

Before you can use a HELOC or cash out refi, let’s take a look at the role of equity. Equity is the difference between your home’s current value and your outstanding mortgage balance. You build equity by making your mortgage payments. It can also increase when property values go up. 

How Do I Calculate My Home Equity?

Calculating your home equity is easy. You need your home’s current value and the balance of your mortgage. The difference between the two is your home’s equity. If you don’t have a recent appraisal, you can get an estimate of your home’s value from sites like Zillow or Realtor.com.

What Is a Home Equity Line of Credit (HELOC)?

A HELOC is an additional loan you take out against your house. It stands for “Home Equity Line Of Credit” (HELOC) and works like a line of credit, similar to how a credit card works. Essentially, it acts as a second mortgage. You get a credit line and can draw on it as needed.

With a HELOC, you only pay interest on the amount you withdraw. Plus, you can make interest-only payments during the draw period. The draw period varies between lenders but can last up to 10 years. 

What Happens After The Draw Period?

After the HELOC draw period, the line of credit closes, and you make principal and interest payments for the remainder of the term.

What Is Cash Out Refi?

A cash-out refi replaces your first mortgage, leaving you with a single mortgage payment. Most borrowers can access up to 80% of their home’s value with a cash out refinance. But that includes the balance of the first mortgage.

For example, let’s say your home is worth $350,000 and your first mortgage is $200,000. If you can only access 80% of your home’s equity, that leaves you with up to $80,000 of equity that you can take out. With a cash-out refinance, you have one mortgage payment.

It's important to keep in mind that it may be larger than your current payment since you’re borrowing more money. 

Is A Cash-out Refinance The Same As A Home Equity Loan?

Put simply, it's not. A home equity loan is a separate second mortgage. You receive funds in a lump sum and make principal and interest payments on the loan for 10 to 20 years.

Similarities Between HELOC vs Cash Out Refi

Both the HELOC and cash out refi tap into your home’s equity. Which is better, cash-out refinance or HELOC will depend on your goals.

But you’ll notice that both loans have some similarities:

• You can tap into your home’s equity to get cash out of the home.
• You can often borrow up to 80% of the home’s current value.
• You can generally use the money any way you want.
• Both loans use your home as collateral for the loan.

Differences Between Cash Out Refi vs HELOC

As much as the cash-out refi and HELOC are similar, there are many differences to consider:

• While a HELOC is a second mortgage, a cash out refi replaces your first mortgage.
• A cash out refi usually has higher closing fees since it's a new mortgage.
• A cash out refi provides all the funds in one lump sum vs. a HELOC that doesn't require you to take the entire amount at once.
• You have the option only to pay interest on a HELOC during the draw period, but principal and interest payments are required on a cash-out refi.

When Is a HELOC Best?

Sometimes a HELOC is the better option, but weigh the pros and cons of both choices before making a decision.

Consider a HELOC when:

• You aren't sure exactly how much money you need. If you're doing home renovations or paying for a large expense, you may not know the amount. Having the opportunity to draw more cash from your home's equity with a line of credit may be best.
• You have a great interest rate on your first mortgage. If you don't want to lose your current interest rate, tapping into your equity with a HELOC leaves the interest rate from your first mortgage untouched.
• You only need a small amount of money. It may not be worth refinancing your first mortgage and paying the closing costs of a cash out refi if you plan to take out a small amount.

When Is a Cash Out Refi Best?

HELOCs are a great choice sometimes. But there are circumstances when a cash out refi is the better option.

For instance, if you need the cash upfront in one lump sum, a cash out refi may be best. It’s also a good option if you know you’ll live in the home for a long time. A cash out refi can help you budget easier because you know exactly how much you’re taking out. You’ll be left with a single mortgage payment and hopefully a lower interest rate that can save you money.

What If You Aren’t Sure If A Cash Out Refi Makes Sense?

If you’re not sure if cash out refinance makes sense for you, a cash-out refi calculator can give you a better idea of where you stand. The good news about cash out refi  is you don’t have to sell your home to tap into the equity.

So, Is A Cash-out Refi A Good Idea?

When considering a HELOC vs cash out refi, you may be asking yourself whether a cash-out refi is a good idea. Ultimately, It depends on how long you’ll be in the home and what you’ll use the money for. If you plan to reinvest in your home by making home renovations, a cash out refi can be one of the best uses of your home’s equity.