Hi, my name is Wilson Cotrim. I’m a Loan Officer with NEXA Mortgage LLC., offering personalized mortgage solutions, fast customized quotes, great rates and service with integrity.
Hi, my name is Wilson Cotrim. I’m a Loan Officer with NEXA Mortgage LLC., offering personalized mortgage solutions, fast customized quotes, great rates and service with integrity.
Hi, my name is Wilson Cotrim. I’m a Loan Officer with NEXA Mortgage LLC., offering personalized mortgage solutions, fast customized quotes, great rates and service with integrity.
Hi, my name is Wilson Cotrim. I’m a Loan Officer with NEXA Mortgage LLC., offering personalized mortgage solutions, fast customized quotes, great rates and service with integrity.
Hi, my name is Wilson Cotrim. I’m a Loan Officer with NEXA Mortgage LLC., offering personalized mortgage solutions, fast customized quotes, great rates and service with integrity.
Hi, my name is Wilson Cotrim. I’m a Loan Officer with NEXA Mortgage LLC., offering personalized mortgage solutions, fast customized quotes, great rates and service with integrity.
When you need money, borrowing against your home can be an easy way to get it. You have two good options to consider: a home equity line of credit (HELOC), or a cash-out refinance on your mortgage. But when it comes to a HELOC vs. cash-out refinance, which is the better choice? Below, we’ll explore HELOC vs. cash-out refinance options to help you discover the best financing option for you.
HELOC vs. cash-out refinance: What's the difference?
HELOCs and cash-out refinances use two very different methods of borrowing.
With a HELOC (home equity line of credit), you borrow against the equity you already have in your home. You get access to a line of credit you can borrow against during a preset time, which is known as your “draw period.” That period is typically 10 years. You don’t accrue interest on your entire line of credit at once; you only accrue interest on the amount you borrow. Note a HELOC doesn’t require you to sign a new mortgage.
With a cash-out refinance, you swap your existing mortgage for a new one. That new mortgage is for a higher amount than your remaining loan balance. So, if you currently owe $150,000 on your mortgage, you might swap it for a $200,000 mortgage. When the new loan closes, you get a check for the excess amount (in this case $50,000). Then, you make monthly mortgage payments to pay off your new mortgage.
Below, we’ll cover some more key differences in the HELOC vs. cash-out refinance realm. If you’re interested in cash-out refinancing, check out our guide on how refinancing works.
How much you can borrow
During a cash-out refinance, the best mortgage lenders generally don’t want the total amount of your new mortgage to exceed 80% of your home’s value. With a HELOC, some lenders let you access between 80%-90% of your home’s value (minus the amount you currently owe on your mortgage).
With a HELOC, you can borrow a little at a time as you need it. You only need to pay interest on the amount you borrow, which can save you thousands in the long run. With a cash-out refinance, you borrow the entire amount all at once — and immediately start paying interest on the full sum.
Credit score needed
For those with a lower credit score, HELOCs are slightly preferable over cash-out refinances. To be approved for a HELOC, you generally need a credit score of 620 or higher. You could qualify for a cash-out refinance with a score as low as 640 — but you may need a score as high as 700. If you’re not there yet, you can work to raise your credit score.
The credit score you need for a cash-out refinance depends on a couple factors. The amount of equity you have in your home (how much of your mortgage you’ve paid off) is important. Additionally, lenders look at your debt-to-income ratio — or how much you owe creditors versus how much you make.
Interest rates
Interest rates for cash-out refinances tend to be lower than interest rates for HELOCs. However, cash-out refinances have fixed interest rates — HELOC interest rates are generally variable. Again, when you use a HELOC, you only pay interest on the amount you’ve borrowed. If you get a cash-out refinance, you pay interest on the full amount from the beginning.
When deciding between a HELOC vs. cash-out refi, remember that the interest rate you pay for a cash-out refinance is simply the interest rate you pay on the new mortgage. And that rate depends on your credit score, debt-to-income ratio, and other factors. Keeping track of current refinance rates will give you a sense of the interest rate you may get.
Repayment terms
If you’re weighing the pros and cons of a HELOC vs. cash-out refinance, repayment terms are an important factor to consider.
After a cash-out refinance, you pay the same amount each month. Usually, these mortgages are paid off in 15-, 20-, or 30-year terms, but some lenders offer custom repayment schedules.
When you open a HELOC, you generally get 10 to 20 years to repay the funds you borrow (but there can be exceptions). Your payment may change from month to month due to variable interest rates.
Pros and cons of HELOC vs. cash-out refinance
Getting a HELOC vs. cash-out refinance — what’s the right call? Let’s review the pros and cons.
Home equity line of credit
Pros of a HELOC:
Qualifying for a HELOC is fairly easy. You don’t need a particularly strong credit score to qualify as long as the equity in your home is there. You can check out our best HELOC lenders to learn more.
HELOC interest can be tax-deductible. You’ll get a tax break if you use the proceeds of your HELOC to improve your home.
HELOCs are flexible. Rather than borrow a lump sum, you can draw against a HELOC as you need to. If you don’t use your entire HELOC, the amount you don’t touch won’t accrue interest.
Cons of a HELOC:
Your home is collateral for the money you borrow. If you fall behind on your payments, you could lose your home.
Variable interest rates. Without a fixed interest rate, your payments over time can become unpredictable (while your HELOC rate could adjust downward, you’ll need to prepare for it to adjust upward as well).
Cash-out refinance
Pros of a cash-out refinance:
Low interest rates. With a cash-out refinance, you generally snag a lower interest rate than with a HELOC, which makes paying off that debt less expensive. This is especially likely if you use one of the best mortgage refinance lenders out there.
Fixed interest rates. With a cash-out refinance, you have a fixed interest rate attached to your loan, so your monthly payments are predictable.
Interest can be tax-deductible. If you itemize on your tax return, you can deduct the interest on the cash-out portion of your refinance if that money is used to improve your home.
Cons of a cash-out refinance:
Your home is collateral for the money you borrow. As with a HELOC, if you do a cash-out refinance and fall behind on your mortgage payments, you risk losing your home.
You’ll need good credit. You’ll generally need a higher credit score to qualify for a cash-out refinance, or one with a competitive interest rate.
How to decide between a HELOC and a cash-out refinance
If you’re torn between a HELOC vs. cash-out refinance, you may want to ask yourself these questions:
Am I certain how much I need to borrow? If you haven’t landed on a specific amount, a HELOC gives you more flexibility. With a cash-out refinance, you’re stuck borrowing the lump sum you’re given at closing.
Am I willing to risk a variable interest rate? The interest rate on your HELOC could climb over time, making your payments more expensive. With a cash-out refinance, your monthly payments are fixed.
How much can I save on interest? With a cash-out refinance, you generally snag a lower interest rate than with a HELOC. It pays to get some quotes and then run the numbers to see what specific difference in rates you’d see.
Choosing between a HELOC vs. cash-out refinance isn’t easy. Ultimately, when it comes to borrowing against your home, there’s no right or wrong answer, so weigh the pros and cons of a HELOC vs. cash-out refinance to see what’s best for you.
You have several choices for borrowing money at your disposal. Personal loans are an option if your credit score is good, and you could also charge expenses on a credit card and pay it off over time. But personal loans aren’t always easy to qualify for, and credit card debt is generally bad news. That’s why you might consider borrowing against your home, provided you have enough equity in it to do so. Not only is that generally an affordable option, but it may offer some tax benefits to boot.
A home equity loan is a way to borrow money using the equity in your home as collateral. Not only can you lock in a lower interest rate than you’d typically get with a credit card or personal loan, but you can also deduct the interest on your taxes in some cases.
But the rules for home equity loans and taxes can get complicated, plus they’ve changed under the Tax Cuts and Jobs Act of 2017. Keep reading to learn about when you can qualify for a tax deduction on home equity loan interest.
What is a home equity loan?
A home equity loan is a type of second mortgage you take out based on the amount of your home you own outright. You borrow a certain sum from a home equity loan lender and then pay it back at a fixed rate over a predetermined period of time. Unlike personal loans, which are usually unsecured loans, a home equity loan uses your home as collateral, which means you risk foreclosure if you can’t afford to repay it.
You can take out a home equity loan for any purpose, including debt consolidation or to pay for a wedding or vacation. But you can only deduct the interest on a home equity loan if it’s used to buy, build, or substantially improve your primary or secondary home.
When is a home equity loan tax deductible?
First of all, only the interest paid on a home equity loan qualifies for a tax deduction. You won’t be allowed to deduct any money you paid toward the loan’s principal. However, you’ll need to itemize your deductions instead of taking the standard deduction in order to deduct the interest.
How much can you deduct?
The rules vary based on whether you secured a home equity loan before or after the passage of the Tax Cuts and Jobs Act of 2017:
For home equity loans taken out before Dec. 16, 2017:
You can deduct mortgage interest, including home equity loan interest, on the first $1 million of mortgage debt. If you’re married and file separate tax returns, you can only deduct interest on the first $500,000 of mortgage debt.
For home equity loans taken out Dec. 16, 2017 or later:
You can only deduct mortgage interest, including home equity loan interest, on the first $750,000 of mortgage debt. If you’re married filing separately, you can only deduct interest on the first $375,000 of mortgage debt.
Limits on deducting home equity loan interest
The Tax Cuts and Jobs Act, or TCJA, didn’t just change how much interest you can deduct for mortgage-related debt. It also narrowed the rules for when you can deduct interest on a home equity loan or home equity line of credit (HELOC).
Before the law took effect, you could deduct home equity loan interest no matter what you used it for. If you used the funds to pay off credit card debt or medical debt, you could still deduct the interest. But TCJA suspended the deduction for home equity loans and HELOCs for tax years 2018 to 2025 unless they’re used to buy, build, or substantially improve a qualifying primary or secondary home.
Why deducting home equity loan interest may not be worth it
To deduct mortgage or home equity loan interest, you’ll need to itemize your deductions at tax time. But for many taxpayers, itemizing is no longer worth it. That’s because the Tax Cuts and Jobs Act nearly doubled the standard deduction, which is the fixed amount you can deduct on your taxes, even if you have no expenses.
The standard deduction for 2023 is $13,850 for single filers and $27,700 for married couples filing jointly. If you don’t have deductions exceeding these thresholds, you’re better off taking the standard deduction, even if that means you can’t deduct home equity loan interest. Nearly 90% of taxpayers now take the standard deduction instead of itemizing, according to IRS data.
Can you deduct HELOC interest on your taxes?
The rules for deducting interest paid on a HELOC — which is a line of credit secured by your home — are the same as those for deducting interest on a home equity loan: The money must be used to buy, build, or substantially improve a qualifying residence in order to deduct the interest.
What are the benefits of a home equity loan?
Home equity loans are attractive for a number of reasons:
- They’re easy to qualify for, provided the equity in your home is there. Even if you don’t have a great credit score, you may still qualify because the loan is secured by your home.
- You’ll generally snag a competitive interest rate on a home equity loan, and a fixed interest rate at that, making your monthly payment on that loan predictable. Interest rates are typically lower than you’d get with a credit card or personal loan.
- Finally, a home equity loan can serve as a tax deduction — but only in limited circumstances, as discussed above.
Should you itemize to deduct home equity loan interest?
Whether itemizing on your tax return makes sense for you will hinge on whether your specific deductions exceed the standard deduction, which changes from year to year. If you don’t pay a lot of mortgage interest, have low property taxes, and only pay a modest amount of interest on a home equity loan or HELOC, then itemizing may not make sense.
If you’re not sure how your home equity loan will affect your taxes, it pays to consult an accountant or tax advisor for more information. But remember, even if you don’t snag a tax break from a home equity loan, it can still be an easy, affordable way to borrow money when you need to.
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