HELOC, Home Equity Loan, Cash Out Refi – What Are the Differences?

Tapping into your home’s equity (the value accrued as a result of your home being worth more on the market than the remaining balance on your mortgage) can be a great way to get the funding you need for life’s major undertakings, including home improvement, consolidating debt and even starting a business.

You can access your equity in different ways: through a home equity loan, home equity line of credit (HELOC) or cash out refinancing. While each of these allow you to borrow against the equity in your home, there are significant differences between each option.

That’s why we wanted to put together a guide detailing these differences — to simplify the process and help you get the best results possible from the equity in your home.

Some Things to Know Beforehand

Before you consider applying for any of the three options below, first take some time to understand these three things:

Knowing these three pieces of information will help you better understand the options available to you. You’ll understand why as you read more.

HELOCs

You can think of a home equity line of credit (HELOC) as a fund available to you over the course of up to 10 years that you can access only when you need to, and only to take out as much as you need at a given time

Every month, you simply pay off the interest on however much you withdraw, with the option to also pay down the principal, similar to how you pay off a credit card. The repayment terms for HELOCs are up to 20 years.

Typical HELOC requirements:

Pros:

A HELOC is perfect for people who foresee needing access to funding over a period of time as opposed to all at once. Plus, HELOCs are relatively inexpensive to set up and you only pay interest on whatever you take out.

Plus, depending on the market and how quickly you intend to pay off your HELOC you may also benefit from a lower variable interest rate than a fixed interest rate associated with a home equity loan or cash out refinance.

Cons:

HELOCs come with variable interest rates that are unpredictable and susceptible to rising down the road.

Home Equity Loans

Where with a HELOC you can access your funding as you need it, with a home equity loan you receive all of your funding as a lump sum. This lump sum usually equates to no more than 80% of the value of your home (as is typical with most home equity loan options).

For example, let’s assume you have a home with a market value of $600,000 and a mortgage of $400,000. We can calculate 80% of the value of your home simply by multiplying .80 x $600,000 to get $480,000. Next, we subtract your mortgage of $400,000 to give you $80,000 — the amount you’re likely to qualify for in the form of a home equity loan.

After receiving your funding, you then pay it back at a fixed rate over a period of 5-30 years. In this sense, a home equity loan is essentially a second mortgage.

Typical Home Equity Loan requirements:

What are the pros of a Home Equity Loan?

If you need access to a lot of funding all at once and want and want the comfort of a fixed interest rate for the entirety of your term, then a home equity loan makes sense. Home equity loans also allow you to access your home equity without having to requalify for a refinance.

And while more expensive than other mortgages, home equity loans can still be used to consolidate debt on account of typically having lower rates than credit cards or personal loans.

What are the cons of a Home Equity Loan?

You’ll pay the most taking out a home equity loan than any other equity loan option, such as a HELOC or cash out refinance.

Cash Out Refinance

Replacing your current mortgage, a cash-out refinance gives you the difference between your remaining mortgage amount and your home’s equity in cash.

And instead of creating a second mortgage on your home, as does a home equity loan, a cash-out refinance loan converts your mortgage into a separate, larger one.

Typical Cash Out Refinance requirements:

What are the pros of Cash Out Refinancing?

Cash out refinancing allows you to refinance and gain fast access to cash at the same time. You also don’t have to worry about having to make two mortgage payments as you do with a home equity loan, as cash out refinance converts your existing mortgage into a new, larger one.

What are the cons of Cash Out Refinancing?

There can be a number of extra fees associated with cash out refinancing, including a break of contract fee, called a prepayment penalty, on your existing mortgage. You also pay interest on the cash amount immediately.
Bottom Line

So that’s a lot of information to take in. To help make choosing the right loan option a little easier, below you can find a quick breakdown of each option, its requirements, as well as its pros and cons at a glance.

Consider a HELOC if…

Consider a Home Equity Loan if…

Consider Cash Out Refinancing if…