If your home is worth more than you owe on it, that difference is your equity. Two common ways to use it are a cash out refinance and a home equity line of credit, often called a HELOC. They can fund the same projects, but they work very differently. The right choice depends on your current mortgage, how you plan to use the money and how you like to repay.
How a cash out refinance works
A cash out refinance replaces your current mortgage with a new, larger loan. At closing, the new loan pays off the old one and you receive the difference in cash. You end up with one loan and one monthly payment.
Because it replaces your first mortgage, a cash out refinance also changes the terms on everything you already owe. That can be helpful if the new terms are better than the ones you have. It can be costly if your current loan has terms you would rather keep.
How a HELOC works
A HELOC is a separate line of credit secured by your home. Your first mortgage stays exactly as it is. The lender sets a credit limit, and you draw money when you need it during a draw period, then repay it during a repayment period.
Most HELOCs have a variable rate, so the payment can change over time. You typically pay interest only on the amount you have actually drawn, not on the full credit limit.
Key differences at a glance
- Your first mortgage. A cash out refinance replaces it. A HELOC leaves it untouched.
- How you receive the money. A cash out refinance pays one lump sum at closing. A HELOC lets you borrow as you go, up to your limit.
- Payments. A cash out refinance usually means one predictable payment. A HELOC adds a second payment that can change with its rate.
- Closing costs. A cash out refinance has the closing costs of a full mortgage. HELOC costs are often lower, but they vary by lender.
When a cash out refinance may fit better
A cash out refinance can make sense when you need one large amount for a specific purpose, prefer a single predictable payment, and the terms of a new loan compare well with the terms of your current one. Some homeowners also use it to consolidate higher cost debt into one payment. Keep in mind that turning unsecured debt into debt secured by your home puts your home at risk if you cannot repay.
When a HELOC may fit better
A HELOC can make sense when you want to keep your current mortgage and its terms, when your costs will come in stages, such as a renovation paid over several months, or when you want access to funds without borrowing all of it at once. Plan for the payment to change if rates move, and for the shift from the draw period to the repayment period.
What lenders look at for either option
Both options depend on how much equity you have, which the lender confirms with an appraisal or another valuation. Lenders also review your credit, your income and your existing debts, including your current mortgage. Programs set limits on how much of your home’s value you can borrow against in total.
Questions to ask yourself
- Do I like the terms of my current mortgage, or would a new loan improve them?
- Do I need one amount now, or money over time?
- How would I feel about a payment that can change?
- How long do I plan to stay in the home?
- Have I compared the total cost of each option, including closing costs?
Get a clear comparison
The best way to choose is to see both options side by side for your home and your plans. If you own a home in Florida, Indiana or Texas, book a free call with Laurie, or read more on our HELOC page.
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