HELOC vs. cash-out refinance: which is better for you?

One of the great things about being a homeowner is that every mortgage payment could help you build equity in your home. Equity is the value of your home above what you owe on it, and it can be a powerful tool to reach other financial goals.

Two great options for taking advantage of your home's equity are a home equity line of credit (HELOC) and a cash-out refinance. Both let you borrow against your home equity to access cash, but they work very differently. 

Here, we’ll break down the differences between a HELOC and a cash-out refinance. Then, we'll show you how to decide which one makes sense for your situation.

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

A HELOC is a reusable line of credit secured by your home equity. It doesn't replace your existing mortgage. A cash-out refinance is when you replace your existing mortgage with a new, larger mortgage based on your home's value. Your old mortgage is paid off and you get the difference as a single cash payment.

Which one is a better fit generally depends on your current mortgage rate and how much you owe on the home.

What is a home equity line of credit (HELOC)?

A HELOC is essentially a reusable home equity loan. During the first few years—it varies by lender—you can borrow up to your credit limit, pay it back down, then borrow again, over and over, just like a credit card.

Once the draw period ends, you enter the repayment period. You can't borrow against your credit line anymore at this point. Now is the time to focus on paying off your HELOC.

The specifics of a HELOC can depend on the type of HELOC you have, but in general:

• All HELOCs are a type of second mortgage. 

• HELOCs are secured loans. You pledge your home as security or collateral to back up the loan. Secured loans are lower risk to the lender, so interest rates are typically lower on HELOCs than on unsecured loans. However, they're riskier for you since your home could be at risk if you stop making payments.

• Most HELOCs have a minimum and a maximum amount you can borrow that is set by the lender. The maximum is often based on a percentage of your home’s value (usually around 80% to 90%).

• All HELOCs have a draw period and a repayment period. During the draw period, usually five to 10 years depending on the lender, you can borrow and repay as you like, up to your credit limit. 

• When the repayment period begins, you can’t borrow more. The repayment period is generally 10 to 20 years depending on the lender.

Types of HELOCS

HELOCs can vary based on the interest rate structure. You have the option of choosing a traditional, hybrid, or fixed-rate HELOC. Here are the differences among the various types of HELOCs.

Traditional HELOC

A traditional HELOC has a variable interest rate. That means that the rate can (and usually does) go up and down, depending on the overall market. Some HELOCs are offered at low teaser rates and then increase to a higher variable rate. Most traditional HELOCs can be converted to a fixed-rate loan when the repayment period starts.

Once you have a traditional HELOC, you might only need to make interest payments during your draw period. After the draw period ends, you’ll need to make regular monthly principal and interest payments. This means your payment amount might rise sharply.

Also, some HELOC payments aren’t calculated to repay the loan by the end of the repayment period. In that case, a balloon payment would eventually come due—a single, often very large, amount to pay off the remaining balance. 

Hybrid HELOC

A hybrid HELOC allows you to lock in your interest rate at different times. You may need to draw your full loan amount at a fixed interest rate at the beginning of your HELOC. As you pay it down, you can borrow again and again during the draw period, but the rate on those advances will be based on the current rates. The number of times you can lock in a rate is usually limited to between two and five.

Fixed-rate HELOC 

A fixed-rate HELOC is just what it sounds like: a HELOC with a fixed interest rate from start to finish. As with any other HELOC, a fixed-rate HELOC lets you borrow, repay, then borrow again, up to your credit limit, as much as you like throughout the draw period—but you get a fixed interest rate the entire time. HELOCs through Achieve Loans come with a fixed rate.

What is a cash-out refinance?

A cash-out refinance replaces your current mortgage with a new one that’s larger than your existing mortgage. Your first mortgage is paid off, and you receive the difference in cash (minus any closing costs), which you can use for any purpose. 

How much cash you can get out with a cash-out refinance will depend on your home's equity. The new mortgage is based on your home's current value, so more equity could mean more cash when you refinance.

Comparing a HELOC with a cash-out refinance

When to use a HELOC vs. a cash-out refinance

Here are some situations when a fixed-rate HELOC is generally a better choice than a cash-out refinance:  

• When you have a great mortgage interest rate. If you have a low existing mortgage rate, you probably don’t want to give that up. A cash-out refinance would mean losing your existing rate and replacing it with a rate based on the current market.

• If your mortgage is almost paid off. You may have been paying your mortgage for years. A cash-out refinance typically starts you over on a new 15- or 30-year mortgage loan, which could extend the time it takes to pay off your home. 

In the past, a traditional HELOC’s variable interest rate could be a major disadvantage for borrowers. A fixed-rate HELOC removes that drawback.

Example of when to choose a HELOC

Spencer and Riley have just gotten married and decide to live in the house Riley purchased 10 years earlier. During the COVID-19 pandemic, Riley refinanced the home, snagging a 3% interest rate and dropping the monthly mortgage payment by hundreds of dollars. 

Now that they’re married, the couple has big plans for the house—but they need cash to complete those plans. They choose a HELOC over a cash-out refinance because they don't want to take on a higher mortgage rate.

When to use a cash-out refinance vs. a HELOC

Sometimes your best bet is to take advantage of a cash-out refinance. Here are a few examples:

• When you aren’t happy with your current interest rate. If refinancing your mortgage would lead to a lower rate, it’s worth considering. This is especially true if you plan to remain in your home long enough to benefit from the lower rate and recoup closing costs.

• If you want a large lump sum. If your home is worth far more than you owe and you can score a lower APR than your current rate, you may find it more useful to get a one-time cash out while you refinance. You won't have two mortgages to juggle and it could simplify your finances.

Example of when to choose a cash-out refi

Ryan and Alex purchased their home in 2023 with a 7.25% interest rate. The house has gone up in value and they want to use the equity to remodel the bathroom. 

Thanks to market changes, they can refinance at 6.0% interest while also getting enough cash to complete the remodel. For them, refinancing makes sense if they plan to live in the house long enough to recoup the closing costs.

How is a cash-out refinance similar to a fixed-rate HELOC?

Both fixed-rate HELOCs and cash-out refinances are types of mortgage loans. Because they are secured by your home, the interest rates for both fixed-rate HELOCs and cash-out refinancing tend to be lower than other ways to borrow money.

Also, both a HELOC and a cash-out refinance are likely to have a higher loan limit than unsecured loans like personal loans or credit cards. 

While being secured by your home helps you get lower rates and larger amounts of money, it does mean that your home could be at risk if you stop making payments. Both a HELOC and a cash-out refinance could wind up in foreclosure if you don't pay as agreed.

How is a cash-out refinance different from a fixed-rate HELOC?

There are four major differences between a fixed-rate HELOC and a cash-out refinance. 

1. Different loan types

• A cash-out refinance replaces your current mortgage with a newer, larger one. 

• A fixed-rate HELOC is a line of credit separate from your current mortgage.

2. How often you can borrow

• For a cash-out refinance, you get a single lump-sum payment and that's it. You’ll have to make a decision upfront about the full amount of money you need. 

• For a fixed-rate HELOC, you can borrow up to your credit limit, pay back some or all of it, then borrow again, over and over during the draw period.

3. Different monthly payment options

• With a cash-out refinance, you’ll have one mortgage payment that includes your existing loan amount plus the new amount you’ve borrowed. You'll immediately begin making principal and interest payments on your full borrowed amount.

• With a HELOC, you’ll make a separate loan payment in addition to your mortgage. You might only have to make interest payments during the draw period. This means that although you’ll be making payments for several years, you won’t make any headway against your balance. Also, your payment will spike when the repayment period begins.

• With a fixed-rate HELOC, you’ll make a separate loan payment in addition to your mortgage. Your payment during the draw period will be based on your statement balance, but it will likely be a principal and interest payment, not interest-only. 

4. Different qualification guidelines

• For a cash-out refinance, most lenders require a credit score of at least 620 if you're refinancing with a conventional loan. Other loan types, like an FHA or VA loan, could have lower score requirements depending on the lender.

• For a fixed-rate HELOC, you could get approved with a credit score as low as 600 (if you’re using the money to pay off other creditors), though it varies by lender.

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

Choosing between a HELOC and cash-out refinance depends on your situation and needs. Here are some questions you can ask yourself to narrow down the best option.

Once you've gotten a sense of which financing method best meets your needs, take time to shop around for the best loan. If you determine that a fixed-rate HELOC is a good fit for your situation, you can check your rate through Achieve Loans without affecting your credit.