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If you’re a homeowner with a good amount of equity in your property, then a cash-out refinance, home equity loan, or home equity line of credit could offer money when you need it.
Whether you’re facing high medical bills or just looking to cover a kitchen remodel, any of these three financing options can give you the cash you need to pay the bills by tapping your home equity.
Here’s a more in-depth look at these loan products — as well as when homeowners may want to use them:
- How a cash-out refinance works
- How home equity loans and HELOCs work
- How cash-out refinancing compares to home equity loans
- How cash-out refinancing compares to HELOCs
- How to choose the right home equity product
How a cash-out refinance works
A cash-out refinance is a method of replacing your existing mortgage loan. It’s a type of mortgage refinance where you apply for a new mortgage that’s larger than your current loan balance.
Once approved, the new loan pays off your old mortgage and any closing costs, and you’ll receive the difference between the two loans in cash. You’ll also get a new monthly mortgage payment based on your new loan terms and balance.
Be sure to shop around and compare rates with multiple lenders if you decide to go with a cash-out refinance. Credible makes this simple. You can get prequalified rates in only three minutes — and it won’t affect your credit score.
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Learn More: Refinance Closing Costs: How to Lower and Avoid Fees
How home equity loans and HELOCs work
Home equity loans and HELOCs are both second mortgages. They allow you to borrow money based on how much equity you have in your home.
With a second mortgage, you’re taking out a completely separate mortgage in addition to your existing one. You’ll pay it down monthly, just like you do with your first mortgage (meaning you’ll have two monthly payments to cover).
More about home equity loans
When you take out a home equity loan, you borrow a lump sum at a fixed interest rate. You begin repaying principal and interest immediately. Lenders offer repayment terms as long as 30 years on these loans. The interest rate is usually higher than the interest rate on a first mortgage.
More about HELOCs
A home equity line of credit establishes an account with a maximum amount that you can borrow from. You can draw what you need during the loan’s first several years (known as the “draw period”), and you’ll only pay interest on the money you actually borrow.
In addition, many lenders only require borrowers to pay interest during the HELOC’s draw period.
Once the draw period ends, you must repay both interest and principal. You might have a draw period of 10 years followed by a repayment period of 20 years, but shorter terms are available, too.
HELOC interest rates are usually higher than mortgage rates but lower than home equity loan rates. Unlike a home equity loan, a HELOC has a variable interest rate. However, some lenders allow you to lock in a fixed rate on a portion of your HELOC borrowing.
The one sure thing is you’ll make your HELOC payment to your HELOC lender and continue making your original mortgage payment just as before.
Read more: Fixed-Rate HELOCs: A Cross Between HELOCs and Home Equity Loans
How cash-out refinancing compares to home equity loans
Both cash-out refinancing and home equity loans allow you to leverage the equity in your home, but they also have important differences.
Similarities between cash-out refinances and home equity loans
The key similarities between cash-out refinances and home equity loans are:
- Both give you a lump-sum payment. You’ll get cash immediately after closing — not in installments or over time.
- Both allow you to use the money for any purpose. You can use the funds for home improvements, tuition, medical bills, and many other costs.
- You might be able to deduct the interest paid on both loans. To do so, the itemized deductions on your tax returns will need to exceed the standard deduction, and you must use the loan proceeds to buy, build, or improve your home.
Learn More: No Closing Cost Refinance: Will It Save You Money?
Differences between cash-out refinances and home equity loans
The major differences between cash-out refinances and home equity loans are:
- A cash-out refinance replaces your existing loan. This means you’ll only have one monthly payment. Meanwhile, a home equity loan adds a separate payment to your monthly bills.
- You can choose an adjustable rate on a cash-out refinance. Home equity loans, on the other hand, have a fixed rate. With an adjustable-rate loan, your rate and payment may rise over time.
- Cash-out refinances typically offer lower interest rates than home equity loans. Home equity loans are riskier for lenders and generally come with higher rates.
- Cash-out refinances typically come with higher closing costs. Many lenders waive the closing costs on home equity loans.
- A home equity loan could be harder to qualify for than a cash-out refinance. Lenders take on more risk with home equity loans, so they’re more strict about who they’ll lend to.
Find Out: Home Equity Loan With Bad Credit: Can It Be Done?
How cash-out refinancing compares to HELOCs
Cash-out refinancing and HELOCs share some similarities, but the most notable difference between the two loans lies in how you access your equity.
Similarities between cash-out refinances and HELOCs
The key similarities between cash-out refinances and HELOCs are:
- Both allow you to use the money for any purpose. You can use the funds for home improvements, tuition, medical bills, and many other costs.
- You might be able to deduct the interest paid on both loans. Like home equity loans, you may be able to deduct the interest you pay on your HELOC as long as the loan proceeds are used to buy, build, or improve your home.
- Both can have adjustable rates. You can choose an adjustable rate on a cash-out refinance, and most HELOCs have variable rates. With an adjustable-rate loan, you may enjoy a lower rate initially, but your rate and payment can also rise over time.
Differences between cash-out refinances and HELOCs
The key differences between cash-out refinances and HELOCs are:
- You’ll receive your equity in different ways. A cash-out refinance gives you a lump-sum payment, while a HELOC allows you to borrow money in installments over time.
- HELOCs add a separate payment to your monthly bill. But with a cash-out refinance you’ll only be responsible for one payment.
- Cash-out refinances typically come with higher closing costs. Similar to home equity loans, many lenders waive the closing costs on HELOCs.
- A HELOC could be harder to qualify for than a cash-out refinance. HELOCs and home equity loans are riskier for lenders since they’re paid second in the event of a foreclosure. As such, they have tighter restrictions for these loans.
Check out: Home Equity Loan or HELOC vs. Reverse Mortgage: How to Choose
How to choose the right home equity product
The right choice depends on your credit score and financial profile, how you plan to use the money, and how your existing mortgage rate compares to current mortgage rates.
When a cash-out refinance makes sense
A cash-out refinance generally makes sense when market interest rates are lower than the rate on your existing home loan.
- You can find a loan with low closing costs
- Your credit or financial profile isn’t good enough to qualify for a home equity loan
- You are consolidating debt and want a low interest rate
- You won’t borrow too much and increase your risk of foreclosure
Find out:
- Reasons for a Cash-Out Refinance: How to Use Your Home Equity
- Using a Cash-Out Refinance to Buy a Second Home: A Good Idea?
When a home equity loan makes sense
A home equity loan generally makes sense if you know you can pay off the loan quickly. Since these loans come with higher interest costs, putting yourself on an accelerated repayment schedule can help minimize how much you’ll pay to borrow the money.
- You can comfortably handle an additional monthly payment
- Market interest rates are higher than your current mortgage rate (and you don’t want to lose that rate by refinancing)
- You plan to use the money toward home improvements and it makes sense to itemize your tax deductions
- You want the security of a fixed interest rate
See: Should You Get a Home Equity Loan for Debt Consolidation?
When a HELOC makes sense
A HELOC generally makes sense if you want to borrow smaller sums over a longer period, or if you want money available to borrow just in case.
Making principal and interest payments during the interest-only draw period (when you’re not required to repay principal) can minimize how much you’ll pay to borrow over the life of the loan.
- You can comfortably add another payment to your monthly expenses
- Market interest rates are higher than your current mortgage rate (and you don’t want to lose that rate by refinancing)
- You plan to use the money toward home improvements and it makes sense to itemize your tax deductions
- You’re comfortable with the risk of a variable interest rate, or you can get a HELOC with a fixed-rate option
Amy Fontinelle contributed to the reporting for this article.
