December 31, 2021
When you own a home, you have an asset you can draw on in a few different ways. Two of the most common are a cash-out refinance and a home equity line of credit (HELOC). Today we’ll discuss the ins and outs of these two different home loans and which one is right for your circumstances.
How to Borrow Money Against Your House
To borrow against your home, you’ll need to have equity. That’s the difference between the value of your home vs. how much you owe. Here’s an example:
- $500,000 home value
- $250,000 mortgage
- 50% LTV
In the above scenario, you’d have enough equity to get a cash-out refinance or HELOC. You’ll want to stay under 80% loan to value (LTV), so you don’t have private mortgage insurance (PMI).
Getting any type of home loan consists of finding the right lender, discussing your options, filling out the application, supplying documentation, going through the loan process, and finally closing on the loan.
A cash-out refinance is similar to when you purchased your home and received your mortgage. This time, you’ll replace your current loan with a new one that has a larger balance. You’ll take the difference in cash at closing. A HELOC typically requires a bit less paperwork, but it depends on the lender.
Instead of refinancing your current mortgage, you can keep it and take out a home equity line of credit (HELOC). That’s an option especially if your current interest rate is low.
Advantages of Cash-Out Refinance vs. Line of Credit
With a cash-out refinance, you’ll have a new single mortgage. Your new loan pays off your current mortgage and gives you funds at closing. The advantage of a cash-out refi is that instead of having a mortgage and a separate line of credit, you only have one loan. That makes paying bills more manageable. Plus, the interest would most likely be lower than a HELOC. You can get a cash-out refi at a fixed or adjustable rate.
A HELOC is secured with your property — just like a regular mortgage. It usually comes in an adjustable interest rate, and often there’s a low introductory period. After that initial period, the interest rate can vary based on the market. With this type of home loan, you draw funds as you need them and pay interest on what you use. If you’re doing a home improvement project that will take months, a HELOC could be a great option because you don’t have to take out the funds all at once.
HELOC vs. Mortgage
Your home secures both a HELOC and mortgage. If you sell your home, you have to pay those loans off. You can also pay these loans down or off early.
With a HELOC, you have access to funds that you can use for anything you choose. For example, if you’ve wanted to do some home renovations, you can. Or, if you have a lot of high-interest credit cards or personal loans, you can pay them off.
A rate-and-term mortgage only finances your home. It doesn’t give you any money at closing. Often a borrower will get a new rate-and-term mortgage to refinance their current one for a lower interest rate and different term. Then once they’ve closed on that loan, they’ll get a HELOC for home improvements or other things they want to pay for.
HELOC vs. Cash-Out Refi
If you get a cash-out refinance, you’ll be increasing the balance of your home loan. That means it will probably take you longer to pay it off. That’s something to consider, especially if you’re getting cash out to pay off debts. The longer the term of your loan, the more interest you’ll end up paying. Compare your options by looking at an amortization schedule. Typically, a cash-out refinance has higher rates than a rate-and-term mortgage where you don’t take cash out.
Closing costs are generally less with a HELOC. If you’re using your HELOC for home improvements, save your receipts and check with your accountant to see if your HELOC interest is tax-deductible. Consult a tax adviser for further information regarding the deductibility of interest and charges.
HELOC vs. Personal Loan
Your home secures a HELOC. A personal loan is unsecured. Depending upon how much equity you have in your home, you may be able to borrow more with a HELOC. Personal loan limits vary by lender but range between $25,000 to $100,000
If you don’t want your property used as loan security, get a personal loan. Otherwise, a HELOC usually has lower interest.
When you’re comparing a HELOC vs. cash-out refi, it depends on your financial goals. Both have their advantages.