How each one works
A cash-out refinance replaces your current mortgage with a new, larger one. The new loan pays off the old one and you receive the difference in cash. You end up with one mortgage, at the new loan's rate, on the whole balance.
A home equity line of credit (HELOC) is a second loan that sits behind your existing mortgage. Your first mortgage stays exactly as it is. The HELOC is a credit line you can draw on as needed, and you pay interest only on what you have drawn.
The biggest difference: your current rate
A cash-out refinance re-prices your entire mortgage, not just the cash you take out. If your current rate is lower than today's rates, a cash-out refinance gives that up on the whole balance. Borrowing a small amount this way can cost far more than its size suggests.
A HELOC leaves the first mortgage untouched. To compare fairly, look at the combined (blended) rate of your first mortgage plus the HELOC, against the single rate on the cash-out loan. The Blended Interest Rate Calculator works out that combined rate, weighted by each balance. The rate is not the whole comparison: closing costs, and whether the cash-out loan restarts a 30-year term, also change which option costs less.
Rates and payments
- HELOC rates are usually variable, often tied to the prime rate, so the payment can change. Some lenders let you fix the rate on part of the balance.
- A HELOC usually has a draw period, commonly around 10 years, when you can borrow and often pay interest only, followed by a repayment period, commonly up to 20 years, when you repay principal and interest and can no longer draw.
- The move from interest-only to full repayment can raise the payment sharply. This "payment shock" is the HELOC detail people most often miss. Some HELOCs have no repayment period at all and instead require the remaining balance in one balloon payment when the draw ends.
- A cash-out refinance is usually a standard amortizing mortgage, often at a fixed rate, with one predictable payment from the start.
Costs
A cash-out refinance carries the full closing costs of a new mortgage. Some of them, such as origination fees, discount points and the lender's title policy, grow with the size of the loan, and a cash-out loan is sized to your whole balance plus the cash. HELOCs usually cost less to open, though some charge an annual fee, a minimum draw, or a fee for closing the line early. Compare the lender's disclosures for both.
Risks to know
- Both are secured by your home. Falling behind on either can lead to foreclosure.
- Lenders limit how much of your home's value you can borrow against in total, counting every loan on the home. The limit varies by lender and loan program.
- A lender can freeze or reduce a HELOC line in certain situations, such as a significant fall in your home's value, so money you were planning to draw may not be there.
- A variable-rate HELOC payment rises when rates rise.
When each tends to fit
A HELOC tends to fit when your current mortgage rate is lower than today's rates, when you need money over time rather than all at once (a renovation paid in stages, for example), or when you expect to repay the amount fairly quickly.
A cash-out refinance tends to fit when today's rates are close to or below your current rate, when you need one lump sum, or when you want a single fixed payment and no variable-rate exposure.
For a HELOC, the HELOC Calculator shows the payment during the draw period (interest only, a percent of the balance, or a fixed amount), the principal-and-interest payment once repayment starts, the jump between them, and total interest over the life of the line.