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HELOC vs. Cash-Out Refinance

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Maurie Backman
Kristi Waterworth
By: Maurie Backman
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Maurie Backman is a personal finance writer who covers topics ranging from Social Security to credit cards to mortgages to REITs. She also has an editing background and appears on live podcasts to talk about financial matters.

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 and  Kristi Waterworth
Kristi Waterworth
Kristi Waterworth

Kristi Waterworth has been a writer since 1995, when words were on paper and card catalogs were cool. She's owned and operated a number of small businesses and developed expertise in digital (and paper) marketing, personal finance, and a hundred other things SMB owners have to know to survive. When she's not banging the keys, Kristi hangs out in her kitchen with her dogs, dropping cheese randomly on the floor.

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When you need money, borrowing against your home can be an easy way to get it. You have two good options to consider: a home equity line of credit (HELOC), or a cash-out refinance on your mortgage. But when it comes to a HELOC vs. cash-out refinance, which is the better choice? Below, we'll explore HELOC vs. cash-out refinance options to help you discover the best financing option for you.

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HELOC vs. cash-out refinance: What's the difference?

HELOCs and cash-out refinances use two very different methods of borrowing.

With a HELOC (home equity line of credit), you borrow against the equity you already have in your home. You get access to a line of credit you can borrow against during a preset time, which is known as your "draw period." That period is typically 10 years. You don't accrue interest on your entire line of credit at once; you only accrue interest on the amount you borrow. Note a HELOC doesn't require you to sign a new mortgage.

With a cash-out refinance, you swap your existing mortgage for a new one. That new mortgage is for a higher amount than your remaining loan balance. So, if you currently owe $150,000 on your mortgage, you might swap it for a $200,000 mortgage. When the new loan closes, you get a check for the excess amount (in this case $50,000). Then, you make monthly mortgage payments to pay off your new mortgage.

Below, we'll cover some more key differences in the HELOC vs. cash-out refinance realm. If you're interested in cash-out refinancing, check out our guide on how refinancing works.

How much you can borrow

During a cash-out refinance, the best mortgage lenders generally don't want the total amount of your new mortgage to exceed 80% of your home's value. With a HELOC, some lenders let you access between 80%-90% of your home's value (minus the amount you currently owe on your mortgage).

With a HELOC, you can borrow a little at a time as you need it. You only need to pay interest on the amount you borrow, which can save you thousands in the long run. With a cash-out refinance, you borrow the entire amount all at once -- and immediately start paying interest on the full sum.

Credit score needed

For those with a lower credit score, HELOCs are slightly preferable over cash-out refinances. To be approved for a HELOC, you generally need a credit score of 620 or higher. You could qualify for a cash-out refinance with a score as low as 640 -- but you may need a score as high as 700. If you're not there yet, you can work to raise your credit score.

The credit score you need for a cash-out refinance depends on a couple factors. The amount of equity you have in your home (how much of your mortgage you've paid off) is important. Additionally, lenders look at your debt-to-income ratio -- or how much you owe creditors versus how much you make.

Interest rates

Interest rates for cash-out refinances tend to be lower than interest rates for HELOCs. However, cash-out refinances have fixed interest rates -- HELOC interest rates are generally variable. Again, when you use a HELOC, you only pay interest on the amount you've borrowed. If you get a cash-out refinance, you pay interest on the full amount from the beginning.

When deciding between a HELOC vs. cash-out refi, remember that the interest rate you pay for a cash-out refinance is simply the interest rate you pay on the new mortgage. And that rate depends on your credit score, debt-to-income ratio, and other factors. Keeping track of current refinance rates will give you a sense of the interest rate you may get.

Repayment terms

If you're weighing the pros and cons of a HELOC vs. cash-out refinance, repayment terms are an important factor to consider.

After a cash-out refinance, you pay the same amount each month. Usually, these mortgages are paid off in 15-, 20-, or 30-year terms, but some lenders offer custom repayment schedules.

When you open a HELOC, you generally get 10 to 20 years to repay the funds you borrow (but there can be exceptions). Your payment may change from month to month due to variable interest rates.

Pros and cons of HELOC vs. cash-out refinance

Getting a HELOC vs. cash-out refinance -- what's the right call? Let's review the pros and cons.

Home equity line of credit

Pros of a HELOC:

  • Qualifying for a HELOC is fairly easy. You don't need a particularly strong credit score to qualify as long as the equity in your home is there. You can check out our best HELOC lenders to learn more.
  • HELOC interest can be tax-deductible. You'll get a tax break if you use the proceeds of your HELOC to improve your home.
  • HELOCs are flexible. Rather than borrow a lump sum, you can draw against a HELOC as you need to. If you don't use your entire HELOC, the amount you don't touch won't accrue interest.

Cons of a HELOC:

  • Your home is collateral for the money you borrow. If you fall behind on your payments, you could lose your home.
  • Variable interest rates. Without a fixed interest rate, your payments over time can become unpredictable (while your HELOC rate could adjust downward, you'll need to prepare for it to adjust upward as well).

Cash-out refinance

Pros of a cash-out refinance:

  • Low interest rates. With a cash-out refinance, you generally snag a lower interest rate than with a HELOC, which makes paying off that debt less expensive. This is especially likely if you use one of the best mortgage refinance lenders out there.
  • Fixed interest rates. With a cash-out refinance, you have a fixed interest rate attached to your loan, so your monthly payments are predictable.
  • Interest can be tax-deductible. If you itemize on your tax return, you can deduct the interest on the cash-out portion of your refinance if that money is used to improve your home.

Cons of a cash-out refinance:

  • Your home is collateral for the money you borrow. As with a HELOC, if you do a cash-out refinance and fall behind on your mortgage payments, you risk losing your home.
  • You'll need good credit. You'll generally need a higher credit score to qualify for a cash-out refinance, or one with a competitive interest rate.

How to decide between a HELOC and a cash-out refinance

If you're torn between a HELOC vs. cash-out refinance, you may want to ask yourself these questions:

  • Am I certain how much I need to borrow? If you haven't landed on a specific amount, a HELOC gives you more flexibility. With a cash-out refinance, you're stuck borrowing the lump sum you're given at closing.
  • Am I willing to risk a variable interest rate? The interest rate on your HELOC could climb over time, making your payments more expensive. With a cash-out refinance, your monthly payments are fixed.
  • How much can I save on interest? With a cash-out refinance, you generally snag a lower interest rate than with a HELOC. It pays to get some quotes and then run the numbers to see what specific difference in rates you'd see.

Choosing between a HELOC vs. cash-out refinance isn't easy. Ultimately, when it comes to borrowing against your home, there's no right or wrong answer, so weigh the pros and cons of a HELOC vs. cash-out refinance to see what's best for you.

Still have questions?

Here are some other questions we've answered:

The Ascent's best mortgage refinance lenders

Refinancing your mortgage could save you hundreds of dollars for your monthly mortgage payment and secure you tens of thousands of dollars in long-term savings. Our experts have reviewed the most popular mortgage refinance companies to find the best options. Some of our experts have even used these lenders themselves to cut their costs.

Best mortgage refinance lenders

FAQs

  • A HELOC lets you borrow against your home equity without signing a new mortgage. A cash-out refinance requires you to get a new mortgage for a total amount above what you owe on your existing loan balance in order to borrow the difference between those amounts.

  • Both cash-out refinances and HELOCs have their pros and cons. Cash-out refinances can be cheaper, interest rate-wise, and offer a predictable repayment schedule. HELOCs are more flexible when it comes to accessing your money.

  • You generally need at least a 640 to do a cash-out refinance, but each mortgage lender sets its own rules.