Once you've built up some equity in your home, you may be wondering about the best way to access the funds so you can complete home improvements, go on a dream vacation, consolidate debt, or achieve another goal.
A HELOC offers an ongoing source of credit and is sometimes called a second mortgage because it's a separate loan. By comparison, a cash-out refinance means you take out a whole new mortgage to replace your existing home loan. Read on to compare a HELOC vs cash-out refinance.
CASH-OUT REFINANCE VS HELOC OVERVIEW
Both a home equity line of credit (HELOC) and a cash-out mortgage refinance need you to have a certain amount of equity in your home before you can access any funds. You can estimate how much equity you have by subtracting your mortgage balance from the current value of your home.
Your home serves as collateral for both a HELOC and cash-out refinance and this means you may get lower rates than for an unsecured personal loan or credit card. You may also be able to borrow significantly more funds than is available through other types of loans.
When considering a cash-out refinance vs HELOC, keep in mind that you can be at risk of losing your home if you don't pay the funds back. That's why you should use the money to pay for significant items on your to-do list and not your regular expenses.
WHAT IS A HELOC?
A home equity line of credit, commonly referred to as a HELOC, is a line of credit that allows you to tap into the equity of your home to access those funds. Similar to a credit card, you can borrow funds up to a set credit limit throughout the “draw period” or set time limit.
WHAT IS A CASH-OUT REFINANCE?
A cash-out refinance is another way to leverage your current home equity. By taking out a larger mortgage on your home and paying off the current mortgage, you can pocket the difference, allowing you to access those funds.
HOW CAN I USE THE FUNDS?
The funds from both a HELOC and a cash-out refinance can be used for just about any purpose, including:
- Consolidate other loans
- Pay off other debt, like high-interest credit cards
- Home improvement projects, remodeling, and repairs
- Vacations or weddings
- Medical expenses
You may need to ask your lender if you can use the funds for college tuition or business expenses.
HELOC VS REFINANCE: WHICH IS RIGHT FOR YOU?
While both of these options can get you the funds you need, you may want to consider the pros and cons to help you decide whether a HELOC or a cash-out refinance is a better fit for you.
HELOC: PROS AND CONS
A HELOC allows you to borrow funds as you need them, which can be especially helpful if your budget hasn’t been finalized or if you intend to use the funds for a variety of purposes. Plus, you only pay interest on the portion of funds you use.
However, you’ll need to pay back the HELOC in addition to your current mortgage payment, which will leave you with two payments to be responsible for. Additionally, be aware that many HELOCs have an introductory interest rate which will rise to a new, variable rate after that period.
CASH-OUT REFINANCE: PROS AND CONS
When you choose to go with a cash-out refinance, you get a new mortgage to replace your old mortgage, and you’ll have a single mortgage payment for a new amount. Having one payment makes budgeting easy, and you’ll receive the extra funds from your equity all at once in a lump sum.
However, there are limitations to cash-out refinancing (also known as a cash-out refi). Because you're taking out a new mortgage, you will get a new rate on your home loan based on what's currently available. If interest rates are higher than when you took out your original mortgage, you may pay more interest each month and more total interest over the life of the new loan.
You’ll also need to ensure that the cash-out funds you receive will be enough to cover whatever you’re planning for, as you can't access more funds the way you can with a HELOC.
HELOC VS REFINANCE KEY DIFFERENCES
Let's continue our comparison of a cash-out refinance vs HELOC by taking a closer look at some of the differences between these home equity tools.
HELOCs usually have variable interest rates. HELOC lenders will offer an initial annual percentage rate (APR) based on current HELOC rates, your credit score, and other factors. Your lender may also offer a low fixed interest rate for an introductory period of six months or similar.
The APR you get for a cash-out refinance is based on what rate you can get for a new mortgage. This means you may choose a fixed-rate mortgage or an adjustable-rate mortgage (ARM), where it's fixed at the beginning of your loan and then adjusts with the markets. Rates are based on current mortgage rates, your credit score, and other factors.
If you choose a fixed-rate mortgage for your refinance, your rate will stay the same for the remaining life of your home loan. If you choose an ARM, your rate will adjust (up or down) with the markets when your initial fixed period ends.
DISTRIBUTION OF FUNDS
A HELOC is a type of revolving credit like a credit card. This means you can use funds and pay them back in an endless cycle. Your draw period to use the funds is 10 years.
Just as it's unwise to max out your credit cards, it's best not to use all your HELOC funds at once. The percentage of funds you use will affect your credit utilization rate or your debt-to-credit ratio, which impacts your credit score.
A cash-out refinance is a new mortgage, so you get all your equity funds at the same time as you close on your new home loan. You cannot access more funds unless you do another refinance (or take out a HELOC or home equity loan).
Your HELOC repayments will be an additional payment to your existing home loan. Just like with a credit card, you will get a monthly statement showing how much funds you used and the minimum amount due. In some cases, you can make interest-only payments during your draw period.
You then pay back the principal in a separate repayment period (possibly with a fixed rate) or you may need to make a balloon payment where you pay some or all of the balance due in one payment.
A cash-out refinance means your new mortgage payment replaces your old mortgage payment. Your new monthly payment may be more or less than before, depending on your new loan amount, new loan term, and new APR.
If you do a cash-out mortgage refinance, you may need to pay all the closing costs of a new home loan. The total fees can be thousands of dollars, depending on your lender or mortgage type.
A HELOC may have a loan origination fee or other administration fees, but these will likely be lower than a refinance.
NEXT STEPS: CHOOSE THE BEST LENDER FOR YOUR NEEDS
Now that we've evaluated a HELOC vs cash out refinance, you might be ready to take the steps to secure your financing. Both of these popular lending options let you use the equity in your home to help you reach your goals, finish your projects, or even consolidate debt.
Wasatch Peaks offers HELOCs with favorable rates, flexible terms, and generous eligibility requirements. You can easily become a member if you live, work, worship, or attend school in Weber, Morgan, or Davis Counties, Utah. Click below for more details!
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