Home values have been on the rise for consecutive years , and many Americans have more equity in their homes than ever before. If you want to tap some of your home equity, you may be thinking about a cash out refinance vs HELOC.
Comparing the HELOC and Cash Out Refinance Loan
- Cash-Out Refinancing replaces your current mortgage with a new one and provides a lump-sum of money at closing.
- HELOC enables you to withdraw funds on demand, so you can borrow and reborrow like a credit card.
What is the difference and which is better?
Below, learn all about cash out refinances and HELOCs, then talk to one of our lending experts to get started on your application.
Cash Out Refinance Features
A cash-out refinance mortgage replaces your first mortgage with another mortgage for a larger amount. You convert part of your equity to cash when you finalize the new mortgage.
For instance, if your home is valued at $500,000 and you have a $200,000 balance, you could potentially do a cash out refinance for $300,000, if you qualify. Two-hundred thousand would pay off the first loan, and the $300,000 would go to you. Many homeowners pull out equity for home improvements or paying off medical bills or credit card debt.
If your home has increased in value and your interest rate is lower than current rates a cash out refinance could be perfect for you. For instance, if you have a 7.5% mortgage and want $100,000 in cash, you may benefit from a cash-out refinance. Mortgage rates in March 2024 are between 6% and 7%, so getting a new mortgage could reduce your monthly payment.
If your current rate is lower than market rates, getting a cash out refinance may not be for you. Instead, consider a home equity line of credit (HELOC).
HELOC Features
A home equity line of credit is a second mortgage that lets you borrow some of your equity, just like a cash out refi does. The funds can also be used for home renovations, paying off debt, or whatever you like. Most lenders limit what you can borrow at 85% of your home’s value.
A HELOC loan may be appropriate for homeowners who have paid off their mortgage but want money to work on the house or pay off debt. If you have a low rate on your first mortgage, a HELOC also could be right for you. Many homeowners today got their mortgage years ago and may have a rate well below current 2024 rates.
A home equity line of credit has a variable interest rate, which can go up or down after the initial fixed period expires. You only pay interest during the 10-year draw period, and then principal and interest after that. A HELOC can be used over and over during the draw period. As you pay off the loan, you can reuse it.
However, if you are nervous about fluctuating rates, you may want to think about a cash out refi. Another option is a home equity loan, which is another second mortgage with a fixed rate.
A HELOC’s rate can vary based on the prime rate established by the Federal Reserve. When rates are falling, you could have a lower rate, but if they rise, your payment will go up. Before making a decision, look up compare the best HELOC rates so you can do a fair comparison to the current interest rates for cash refinancing.
Which Is Better Cash Out Refinancing or Taking Out a HELOC Line of Credit?
Taking out a second mortgage in the form of a HELOC offers significant advantages, notably the relatively low borrowing costs. For well-qualified borrowers, exploring a HELOC with no closing costs is an option.
Additionally, during the draw period, most credit lines mandate only interest-only payments.
One major benefit of choosing a HELOC over a cash-out refinance, particularly if you have a low mortgage rate, is the retention of a potentially advantageous APR secured in recent years.
Another approach to prioritizing between a HELOC and a cash out refinance involves determining how you prefer to receive your funds: either as a flexible line of credit available for withdrawal as needed with a home equity line of credit or as a single lump-sum disbursement through a refinance.
It’s worth noting a third alternative: a home equity loan, suitable for borrowers who favor the features of HELOCs but desire an all-at-once payout. If you have low fico scores, you may want to consider a bad credit HELOC program.
Therefore, if you seek an upfront lump-sum payment and aim to refinance your existing home loan for better terms or an extended payoff period to reduce monthly expenses, a cash-out refinance might be the optimal choice.
This is particularly true if you qualify for interest deductions on the cash-out refinance loan but not on the HELOC.
Do You Need a New Appraisal with a HELOC or Cash Out Refinance?
Yes, generally, a HELOC requires an appraisal, although in many instances the HELOC lender will require a less comprehensive appraisal compared to what’s needed for a cash-out refinance mortgage.
Some niche lenders will only require a statistical or desktop review appraisal with a HELOC line of credit. This desktop appraisal, offers a faster and more cost-effective method for assessing a property’s value. Utilizing electronic data sourced from platforms like home listing websites or proprietary databases, this appraisal process eliminates the need for physical property inspections.
Many HELOC lenders will require a statistical or “drive-by” appraisal before approving the home equity line of credit. This type of appraisal is less expensive than a full appraisal.
Whereas, most mortgage lenders will require a full URAR appraisal when a borrower is seeking a cash-out refinance transaction.
Most mortgage bankers require an appraisal before officially approving a HELOC or cash out refinance to safeguard their investment. Essentially, they seek assurance that the property’s value aligns with the HELOC or refinance loan amount.
This ensures that in the event of loan default, the lender can recoup their funds by foreclosing on the property. If the loan exceeds the home’s value, it poses a significant risk to the lender’s investment.
Are You Fearful of Rising Interest Rates?
Homeowners who favor stability may find comfort in fixed rates, making a cash-out refinance the preferable option, as it ensures consistent payments throughout. However, for those comfortable with adjustable rates, home equity credit lines might provide access to more equity overall. It’s important to acknowledge that while HELOC loans offer flexibility, their interest rates typically tend to be slightly higher.
Comparing Closing Costs on HELOCs and Cash Out Refinancing
HELOCs usually entail lower closing expenses compared to a cash-out mortgage refinance and may conclude more swiftly, allowing you to access your funds sooner. Both the HELOC loan and cash out refinance are secured real estate loans so there are typical mortgage closing costs. Both loans have processing underwriting, credit reports, escrow, notary fees, appraisal fees and origination fees.
Many HELOC lenders will pay or waive some of the HELOC closing costs. There are still a few mortgage companies that offer no cost refinancing and no closing cost HELOCs. Always ask the loan officer to see the Good Faith Estimate so you can compare closing costs when shopping HELOCs and cash out refinancing.
How the HELOC and Cash Out Refi Payments Differ
Moreover, with a home equity line of credit, you will only incur interest on the amount you utilize, rather than the entire credit line. For example, If you borrow $25,000 out of your $100,000 HELOC, you will be required to pay interest in the $25,000 you used rather than the entire $100,000 amount. So with this example, you will be required to make an interest only payment monthly on the $25,000 of the HELOC you used.
Lets say you refinanced a $300,000 mortgage and took out an additional $100,000 cash out for a total of $400,000. The borrower will be required to make a monthly payment on the entire $400,000 even if you do not use all the money.
Choosing between a Refinance and Home Equity Line of Credit
Many homeowners are flush with cash in their homes this year after the recent historic rise in the real US real estate market. Those who need cash may be eying cash out refinance and HELOC loans.
If you have a high rate on your first mortgage, it could be time to get a cash out refi, lower your rate, and obtain the cash you need. If your rate on your first is already low, a HELOC could be more appropriate.
Your lender is the best resource for all of your loan needs and questions. Talk to one of our experts today and we’ll help you decide between a cash out refinance vs a HELOC.