Cash-Out refinance Vs. HELOC: which one to choose?

  • Cash-in refinancing involves replacing your existing mortgage with a new one.
  • A HELOC is a second mortgage that works like a credit card, allowing you to withdraw funds as needed.
  • Either option can make sense for turning your home equity into cash if you get the right interest rate.

When the value of your home increases, tapping into the increased equity can be a smart financial decision. You can use the money to get rid of higher interest debt, pay for renovations and repairs, or pretty much any other purpose you can imagine.

Cash-out refinancing and home equity lines of credit (HELOCs) are among the most popular mechanisms for accessing that equity and turning it into cash.

Cash-In Refinance vs. Home Equity Line of Credit: At a Glance

While cash-out refinancing and HELOCs can both help you access the equity in your home, there are some key differences between them that are important to understand.

  • cash refinancing it’s when you replace your current mortgage with a new, larger loan. The new loan pays off the old one and you get the difference between these two balances in cash.
  • A HELOC is a second mortgage. It uses your capital as collateral and you get a line of credit that you can withdraw from for a fixed period (usually 10 years). It works much like a credit card and usually has an adjustable interest rate.

Homeowners can use either option to access the equity they’ve built up in their home at rates that are often lower than other forms of credit such as credit cards, says Steve Kaminski, Head of US Residential Lending at TD Bank.

“Mortgage refinancing transactions generally require

closing costs

than a home equity line of credit and may take longer to process and receive the funds,” says Kaminski. “A HELOC adds a second loan, therefore the borrower will have two payments to manage against one.

What is cash-in refinancing?

With a cash-out refinance, you replace your current mortgage with a new, larger one. The new loan pays off the old one and you receive the difference between the two balances in cash.

“A cash refinance allows a homeowner with some equity in their home to take out a new mortgage for more than they currently owe on the existing one and pocket the difference in cash, minus any closing costs,” said Rob Heck, vice president. mortgage to Morty.

A cash-out refinance could be a good option if mortgage rates are low, as it could allow you to replace your existing mortgage with a lower-rate loan. It can also be a good choice if you want to consolidate higher interest debt, such as credit cards, or if you have fixed costs to cover. (Cash-in refinance comes with a one-time lump sum payment, while HELOCs allow you to withdraw cash as needed.)

Cash-out refinancing is probably not a good idea if you need to trade a low interest rate for a higher rate or if you are in financial difficulty.

“With a cash refinance, your payment can increase significantly depending on market rates combined with the increase in loan amount,” says Kaminski. “A refi with drawdown is usually a good option when home values ​​have risen and mortgage interest rates are low.”

Advantages and disadvantages of cash-in refinancing

Cash Refinance Example

Here’s how a typical cash-out refinance might work:

Let’s say you have an existing mortgage with a balance of $200,000 and your home is worth $400,000. If you needed the cash, you could refinance cash into a $300,000 loan. Then $200,000 of that would be used to pay off your old mortgage, and you would get the remaining $100,000 back in cash.

What is a HELOC?

A HELOC works much like a credit card. You get a revolving line of credit based on your principal and you can withdraw funds from this line of credit as needed during the first 10 years. This is called the drawdown period. You will only pay interest on the balance used during this period.

“Unlike a cash refinance, a home equity loan does not replace your first mortgage,” Heck says. “Instead, you get a second mortgage with a higher interest rate.”

Once the initial 10-year period is over, you will need to pay off the balance – either in one lump sum or in monthly installments (this will depend on your lender and HELOC terms). HELOCs typically have variable interest rates, which means your rate — and your payments — can fluctuate over time.

“HELOCs can provide more flexibility in managing the loan capital on your home,” says Kaminski. “It works a bit like a credit card as a revolving line of credit that you can draw on as needed, but potentially for much larger amounts. It can be extremely useful when managing

home renovation

projects where the availability of funds is needed over time, rather than all at once. »

HELOCs also typically have lower closing costs than a cash refinance and can close faster, meaning you can start using your funds sooner. Plus, you’ll only pay interest on the funds you use, rather than the entire line of credit.

“A HELOC is like a credit card in that you don’t pay interest until you spend money, whereas a cash refinance is like getting a cash advance,” says Jodi Hall, President of Nationwide Mortgage Bankers. “You pay interest as soon as the money is in hand.”

The big downside to a HELOC is that it’s a second mortgage, which means you’ll have an extra payment on top of your existing mortgage. Your payments may also fluctuate.

“HELOCs are based on a variable rate – and linked to the

preferential rate

– which could increase in the future as the prime rate increases,” says Kaminski.

Advantages and disadvantages of HELOC

Example of HELOC

Let’s walk through a potential HELOC scenario:

Let’s say you have an existing mortgage balance of $200,000 and your home is worth $400,000. Since most lenders allow you to borrow up to 85% of the combined value of your home, that leaves you with $140,000 that you can access through a HELOC (.80 x 400,000 – 200,000).

Once approved for this $140,000 HELOC, you’ll get a checkbook or debit card that you can use to withdraw from your line of credit. You could withdraw money as needed for the first 10 years of the loan, and you would only pay interest on the funds withdrawn for that period. At the end of this initial 10-year period, you will make monthly principal and interest payments until the balance is paid off. (You usually have 20 years to repay).

Consult a pro

The choice between a HELOC and a cash refinance is not always clear. If you’re unsure which one would best suit your needs as a homeowner, consult a mortgage or tax advisor for advice.

Whichever you choose, be sure to shop around for your loan. Rates and terms can vary widely from lender to lender, so getting at least a few quotes can help you get the best deal possible.