Cash-out refinance vs. home equity loan vs. HELOC: Which is right for you?

You've built equity in your home, and now you have a goal to fund. That might be a renovation or a major expense. Or it could be consolidating high-interest unsecured debt.  

The question is how to put that equity to work in a way that fits your budget. The best fit among a typical cash-out refinance, home equity loan, or HELOC depends on your current mortgage, how much you need, and how you want to repay. 

Here's how each option works, what each one costs, and how to decide which fits your situation.

What is a cash-out refinance?

A cash-out refinance replaces your existing mortgage with a new, larger one, and you receive the difference in cash at closing. Your old mortgage closes, and you start fresh with a new rate, a new repayment timeline, and a single monthly payment on the new loan.

Say your home is worth $400,000 and you owe $200,000. You could refinance into a new $275,000 loan and receive about $75,000 in cash, minus closing costs. Most lenders want you to keep at least 20% equity after the refinance, which generally limits the new loan to around 80% of your home's value. Closing costs typically run 2% to 5% of the new loan amount.

One trade-off to consider is that a cash-out refinance resets your payment progress. If you're several years into your current mortgage, a new loan resets the clock on a new term—often 15 or 30 years, though other terms may be available depending on the lender.

What is a home equity loan?

A home equity loan is a second mortgage. Your original loan remains in place, as it is. You receive a one-time payment and repay it at a fixed rate over a separate term, typically between 5 and 30 years.

Using the previous example, if your home is worth $400,000 and you owe $200,000, you have $200,000 in home equity. You might be able to borrow against a portion of that equity through a home equity loan. You'd keep your current mortgage payment and add a second payment on the new loan.

A home equity loan sits in second position behind your first mortgage, which means that in the case of foreclosure, the home equity lender gets paid after the first mortgage lender. If there’s not enough from the sale of your home to cover both mortgages, the home equity lender may not recover all the money that was lent. Home equity lenders take on more risk, and that risk is reflected in a higher interest rate than you'd get with a cash-out refinance.

What is a HELOC?

A HELOC is a line of credit you can borrow from over time. You're approved for a maximum credit limit based on your home equity, income, and credit profile. During the draw period, which typically lasts five to 10 years, you can borrow, repay some or all of that balance, and borrow again up to your credit limit, over and over.

Some lenders only require interest payments in the draw period, and so the balance you owe stays the same. How a HELOC works depends, in part, on the lender. With a HELOC through Achieve Loans, you pay full principal plus interest during the draw period and the repayment period.

After the draw period, the repayment period begins. You can’t borrow more during the repayment period, and you pay both principal and interest for the rest of the loan term. HELOCs typically have variable interest rates, so your payment could go up or down based on market conditions. HELOCs through Achieve Loans have a fixed interest rate. 

There are also typically upfront fees, with HELOC closing costs generally ranging from 2% to 5% of the loan amount.

A HELOC could work well if you want to borrow against your home without changing anything about your mortgage. For example, if you have a low mortgage rate, you may want to keep it. Instead of refinancing, you could get a HELOC and keep your mortgage intact.

Cash-out refinance vs. home equity loan vs. HELOC: Key differences

Here's how the three options compare side by side.

The biggest differences come down to your mortgage and your rate. A cash-out refinance replaces your first mortgage, so its rate tends to be lower than a second-mortgage rate. The total cost depends on whether you're giving up a low existing rate. A home equity loan and a HELOC both leave your first mortgage in place, which keeps that rate intact.

When a cash-out refinance could make sense

A cash-out refinance could make sense when:

• You can refinance at a lower rate than your current mortgage.

• You prefer a single monthly payment instead of adding a second one.

• You want to extend your loan term for a smaller monthly payment. Keep in mind you'd pay more interest over time.

• You need a large sum and want to roll it into your primary mortgage.

In a higher-rate market, a cash-out refinance is less appealing if your existing rate is lower than today's rates, since refinancing would replace your low rate across the entire balance.

When a home equity loan could be a better fit

A home equity loan could be the stronger fit when:

• You already have a low-rate mortgage you don't want to lose.

• You want a fixed rate and a predictable monthly payment on your second loan.

• You need a specific amount for a one-time expense, such as a renovation, medical costs, or the consolidation of high-interest unsecured debt.

• You don't want to reset your mortgage payment progress.

• You want lower closing costs than a full refinance.

A home equity loan could also work well for consolidating high-interest unsecured debt into a single fixed-rate payment, since a home-secured loan generally carries a lower rate than credit cards or other unsecured borrowing. 

When a HELOC could work for you

A HELOC could work for you when:

• You want to keep your existing mortgage intact.

• You're not sure exactly how much you'll need, but you have a general range in mind.

• You value the revolving structure: borrow, repay, and borrow again up to your credit limit.

Achieve Loans offers a fixed-rate HELOC, which gives you rate certainty that most variable-rate HELOCs don't. To learn more, find out if you qualify.

How to decide which option is right for you

Choosing an option that fits your situation usually comes down to your current rate and how you want to borrow:

• You have a great mortgage rate and need cash for one big project. A home equity loan keeps your rate and gives you a fixed payment.

• You have a great rate and want flexible borrowing over time. A HELOC gives you the ability to borrow, repay, and borrow again up to your credit limit while keeping your mortgage.

• Your mortgage rate is higher than today's rates, and you need cash. A cash-out refinance could lower your rate and free up cash at the same time.

• You want to consolidate debt and simplify payments. Any of the three could fit, depending on your rate and how much you owe.

A debt-to-income (DTI) ratio calculator could be a helpful tool to get a general idea of where you stand before you apply. The next step is to talk through the numbers for your specific situation. 

Find out if you qualify.