Comparing options
HELOC, home equity loan or cash-out refinance: how to think about the choice
A homeowner who wants to borrow against equity usually meets three products: a home equity line of credit, a home equity loan and a cash-out refinance. They look alike on a brochure but behave differently. This guide compares them by two plain tests: how you receive the money, and what happens to your first mortgage.
In this guide
Start with what the money is forTest one: how you receive the moneyTest two: what happens to the first mortgageHow the rates behaveHow long you will hold the debtHow the costs differA worked comparisonQuestions to put to any lenderKey takeaways
- The three products differ most in how the money arrives and what happens to the first mortgage.
- A line of credit gives access over time, while the other two pay one lump sum.
- A refinance replaces the first mortgage, so its rate and term change along with the new cash.
- The right comparison puts the total cost of each route on the same page.
Start with what the money is for
Before comparing products, write down what you plan to pay for and when the bills arrive. A project paid in stages calls for different borrowing than a single expense due next month.
Equity is the value of your home minus what you owe against it. All three products let you turn part of it into cash, and all three use the home as collateral, which means the lender can claim the home if the debt goes unpaid.
Test one: how you receive the money
This test separates the line of credit from the other two.
- Home equity line of credit (HELOC). You are given a limit and borrow from it as needed. You can repay and borrow again during the draw period, the years when the line is open for borrowing, and you owe interest on what you have used.
- Home equity loan. You receive the whole amount at once and repay it in scheduled payments. You cannot borrow more without applying again.
- Cash-out refinance. You receive a lump sum at closing, taken from the new, larger mortgage.
If your costs come in pieces, or the total is uncertain, a line fits the pattern. If the total is known and due now, a lump sum does.
Test two: what happens to the first mortgage
This test separates the refinance from the other two.
A line of credit and a home equity loan usually sit behind your first mortgage as a second loan. Your first mortgage keeps its rate, its balance and its end date. You add a second payment.
A cash-out refinance pays off the first mortgage and replaces it with a new one. Its rate, term and monthly payment all reset, and the new balance includes the cash you took out. You make one payment instead of two.
That makes the refinance a decision about your whole mortgage, not only about the extra money. Ask what the new rate would be on the full balance, and compare it with the rate you hold now.
How the rates behave
A HELOC usually has a variable rate, so the payment can move. A home equity loan usually has a fixed rate, so the payment stays level. A refinance can be fixed or adjustable.
Fixed means the payment is easy to plan around. Variable means it may start lower and can rise later. Neither is better in the abstract; it depends on how long you will carry the balance and how much change you can absorb.
How long you will hold the debt
The time you expect to carry the borrowing changes which product looks sensible. A short-term need favors a product with low fees at the start, since there is little time to spread them out. A long-term need favors a product with a steady payment and a rate you can plan around.
A refinance is often held for many years, because the new mortgage runs for a full term. A line of credit has a draw period and then a repayment period. A home equity loan has a set schedule from the first day. Match the schedule to how you expect your plans to unfold.
How the costs differ
Each route has its own fees. A line may charge a yearly fee and an early closure fee. A home equity loan usually has closing costs. A refinance often has the largest closing costs because it replaces the whole mortgage, and those costs may be rolled into the new balance.
Ask each lender for a written list, and compare the total cost over the years you expect to hold the debt, not only the first payment.
A worked comparison
Round numbers, shown as an illustration and not an offer. A home is worth $400,000 and the first mortgage balance is $200,000. The owner wants $40,000.
With a line or a loan, the first mortgage stays at $200,000, and a second balance of $40,000 is added. The owner pays both.
With a cash-out refinance, a new mortgage of $240,000 pays off the old $200,000 and hands over $40,000. The owner pays one loan, but all $240,000 now carries the new rate and term.
These figures only show the structure. They are not an offer, and no rate or fee is implied.
Questions to put to any lender
- How do I receive the money, and can I borrow more later?
- Does my first mortgage stay as it is?
- Is the rate fixed or variable, and what is the highest it can reach?
- What are all the fees, and which apply if I close early?
- What would the payment be once the full balance is drawn and repayment begins?
Write each answer beside the product it describes, then compare the three on the same balance over the years you expect to hold the debt.
A note on this page. We wrote this as general background on borrowing against a home. Your own figures, terms and choices will depend on your lender and your circumstances.