which is better cash out refinance or home equity line of credit

Table of Contents

Introduction

When homeowners need to access equity in their property, two of the most common options are a cash out refinance or a home equity line of credit (HELOC). However, determining which one is more suitable for your requirements can be a challenging task.While both allow withdrawing home equity for various uses, there are some key differences between these two financial products.

This comprehensive guide will compare cash out refinancing and HELOCs to help you determine the better choice based on your specific situation. We’ll look at interest rates, costs, loan amounts, tax benefits, credit impacts, intended uses, and more. Understanding the pros and cons of each can lead to making a well-informed decision when tapping into your home’s equity.

What is a Cash Out Refinance?

A cash out refinance involves taking out a new mortgage for more than what you currently owe on your home. The proceeds above your existing loan balance are paid out to you as a tax-free cash lump sum. This allows converting equity that was locked up in your home into usable funds.

For example, if your current mortgage is $100,000, but your home is now worth $300,000, you have $200,000 in equity. You could cash-out refinance for $250,000. After paying off the current $100k loan, you’d get the extra $150k in cash.

What is a Home Equity Line of Credit (HELOC)?

A HELOC is a revolving line of credit where your home acts as collateral, allowing you to borrow against your equity. You have a set credit limit and can draw money as needed until you reach that limit. It works similarly to a credit card, with flexible ongoing access to funds and interest usually charged only on balances carried month-to-month.

Comparing Interest Rates and Fees

Cash out refinancing generally offers a lower interest rate than HELOCs. Refinances have fixed rates, while HELOCs have adjustable interest rates tied to prime or LIBOR. This means your HELOC rate and payment could go up over time.

Closing costs are usually higher for a refinance, around 2% to 6% of the total loan amount. Many HELOCs have no upfront fees, but you may pay application or appraisal fees.

Loan Amounts and Equity Requirements

HELOCs allow accessing smaller amounts of equity as needed, while a cash out refinance provides your equity in one large lump sum. Most lenders will refinance up to 80% loan-to-value (LTV) based on your home’s appraised value. This determines the maximum cash you can take out.

HELOCs often allow higher LTVs up to 90% or more. But total combined loans cannot exceed 80% LTV. This gives flexibility if you have an existing mortgage.

Tax Benefits and Repayment Structures

For primary residences, HELOC interest is usually tax deductible, while cash out refinancing interest is not. Consult a tax expert to be sure.

HELOCs offer flexible repayment structures where you only need to pay interest on outstanding balances each month. A cash-out refinance has a fixed monthly mortgage payment consisting of principal and interest.

Ease and Speed of Accessing Funds

Opening a HELOC is faster with minimal paperwork, usually 2 to 4 weeks for approval. But you likely won’t have immediate access to all of your approved credit limit.

Closing a cash out refinance takes 45-60 days. But once closed, the lump sum payout delivers your full approved loan amount immediately.

Good Uses for Cash-Out Refi vs HELOC

If you need funds for a large one-time expense like a home remodel or major life event, a cash out refinance provides money upfront in a single lump sum. This can be better than a HELOC where you slowly draw money out over time.

If you have ongoing borrowing needs for expenses like home repairs, education costs, or debt consolidation, the revolving credit access of a HELOC is ideal.

Impact on Credit Score

Closing a cash-out refinance may result in a temporary drop in your credit score due to the hard inquiry and higher credit utilization ratio. But responsible management of the funds can improve your score long-term.

HELOC inquiries have a lower impact on your score than refinancing. Ongoing management of credit utilization is key. Converting equity into available credit could also improve ratios.

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Deciding Which Option is Best for You

There are clear tradeoffs between cash out refinancing and HELOCs. Your specific financial situation should steer you toward the better choice:

A Cash-Out Refinance May be Better If:

You need a large lump sum for a big expense.
You want fixed interest rates and payments.
You can quality for lower rates than a HELOC.
You have high existing mortgage rates and want to refinance.

A HELOC May be Better If:

You need access to moderate amounts of cash as needed.
You want flexibility in repayment structures.
You may benefit from tax deductible interest.
You want to preserve low first mortgage rates.

For many, using both financial tools strategically can be beneficial based on evolving needs over time. Consulting mortgage and tax professionals can provide guidance for your situation. Crunching the numbers to compare total costs is key before tapping into your home equity through either method.

FAQs

What is the difference between a cash-out refinance and a HELOC?
1. A cash-out refinance is taking out a new mortgage for more than you currently owe, converting home equity into cash. A HELOC is a revolving credit line secured by your home equity that you can access as needed.
Which has lower interest rates, a cash out refinance or home equity line of credit?
1. Cash-out refinances generally have lower fixed interest rates than HELOCs which have adjustable interest rates.
Can I get tax benefits from a cash-out refinance?
1. No, cash-out refinancing interest is usually not tax deductible for a primary residence. HELOC interest is often tax deductible.
Which option gives me funds faster?
1. A cash-out refinance provides your approved loan amount in a lump sum at closing. A HELOC gives flexible ongoing access but may take longer to access large sums.
When is a cash-out refinance better than a HELOC?
1. Cash-out refinancing is better for large one-time expenses where you need funds upfront. A HELOC is preferable for ongoing borrowing needs where flexibility is key.