HELOC vs. Cash-Out Refinance

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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.

 
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Are Home Equity Loans Tax-Deductible?

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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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What Is a Home Equity Line of Credit (HELOC)?

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There are many different kinds of mortgages that homeowners can use to tap into the equity in their properties. If you want to borrow against your home’s value, a home equity line of credit (HELOC) is one option. But what is a HELOC? This guide will help you understand, and can assist you in deciding if a HELOC is right for you.

What is a HELOC?

A HELOC is a loan you take against your home. When you apply for a HELOC, the lender evaluates your financial credentials and the value of your home. You’re given access to a line of credit with a maximum borrowing limit determined based on those factors.

You are allowed to borrow up to the credit limit your lender allows, just like with a credit card. But the interest rate on a HELOC is much lower than on a credit card or other types of debt. Your home serves as collateral for the loan and if you don’t make your monthly payment then your lender can foreclose. Your line of credit is usually available for a set time, such as 20 years.

How does a HELOC work?

If you have equity in your home, a HELOC is an option for you. You will need to go through the process of applying for a mortgage with a lender offering home equity loans.

If you are approved, the lender will tell you the maximum you can borrow. For example, you may be extended a $40,000 line of credit. You do not have to borrow that amount up front. You can access your line of credit as often as you’d like, up to your credit line. As you pay back what you’ve borrowed, you can draw from your credit line again.

Your payments on your HELOC loan will be based on the amount you have borrowed and your interest rate. Usually, the line of credit is extended for a set period of time, such as 20 years. At the end of your repayment period, you’ll no longer be able to access your credit line.

How much can you borrow with a home equity line of credit?

When answering the question “what is a HELOC?” you need to understand how much you are allowed to borrow. The specific amount varies based on lender rules, the balance on other home loans, and the value of your home.

Many HELOC lenders cap your total loan balances at 75% of what your home is worth. This includes your current loan and your home equity line of credit. For example, if your house was worth $100,000, you would be allowed total mortgage loans of no greater than $75,000. If you already owed $50,000 on your existing mortgage, you’d be allowed at most a $25,000 credit limit on your HELOC.

Some lenders have more relaxed borrowing rules and may allow you to take a HELOC valued at up to 90% of what your home is worth.

Types of HELOCs

It is important to understand different mortgage types when answering the question “what is a HELOC?”

Most HELOCs are variable-rate loans, which means the interest rate is tied to a financial index and can change over time. This could make your loan more expensive if rates go up. There are some lenders that offer fixed-rate loans though. You should check current mortgage interest rates to compare fixed- and adjustable-rate loan options.

Be aware of the risk with variable rates
While variable-rate loans typically have lower starting rates than fixed-rate loan options, you should be aware that rates could go up. Be sure you understand the risks of a variable-rate loan.

What can you use a HELOC for?

You can generally access the funds from your home equity line of credit to be used for any purpose.

Debt consolidation is one common use for HELOC funds because you may be able to substantially reduce the interest rate on your current debt. That’s because a HELOC often comes with a lower interest rate than other loans.

HELOC money is also used frequently for home improvement costs and interest can be tax deductible provided that the money is used to substantially improve, buy, or build the home that’s guaranteeing the HELOC.

HELOC three-day cancellation rule
Under the law, you have three days to change your mind and rescind your credit agreement after you sign for a HELOC and receive your Truth in Lending disclosure detailing total costs. You will need to request this in writing. Your lender cannot allow you to access the funds in your line of credit until after the three days have passed.

HELOC costs
When you research “what is a HELOC?” you need to understand there are closing costs with this loan, just like when you received your mortgage. These are usually around 2% to 5% of your home’s value and include fees for an appraisal; credit report; a loan origination fee; and title insurance. Some lenders also charge an annual fee, so be sure to check.

No-fee HELOCS
Some lenders offer “no-fee HELOCs.” But, fees are typically paid for in other ways with these loans, such as in the form of a higher interest rate.

Is a home equity line of credit right for you?

There are advantages and disadvantages to HELOCs you must consider when answering the question “what is a HELOC?” and determining whether one is right for you.

Pros of HELOCs

These are the biggest advantages of HELOCs:

  • HELOC rates are usually lower than other kinds of debts, such as credit cards.
  • You have flexibility in how much you borrow as you can access as much or as little of your line of credit as you need and can borrow again once you’ve made payments.
  • HELOC interest can be tax deductible under certain circumstances, such as when you use the proceeds from the loan to buy, build, or substantially improve your house. You’ll also need to itemize your taxes.
  • If you want access to a line of credit at a low rate that you can draw from as needed, a HELOC may be a good option for you.

Cons of HELOCs

There are also some downsides to HELOCs including the following:

  • Most are variable-rate loans, so your rate can change over time and your monthly payments could rise.
  • You are putting your home at risk of foreclosure if you can’t make your payments.
  • Your total borrowing costs are uncertain because you can borrow as often as you’d like up to your credit limit.
  • If you’d prefer a fixed-rate loan with a steady repayment schedule, applying with one of the best home equity loan lenders may be a better option than getting a HELOC.

Alternatives to HELOCs

When you are looking into the question of “what is a HELOC?” you should compare home equity lines of credit to common alternatives.

 

HELOCs vs. home equity loans

Is a home equity line or a home equity line of credit right for you when you want to borrow against your home? It depends on your goals.

 

Home equity loans allow you to borrow a fixed amount and you have a choice of fixed- or variable-rate loans. You can’t just borrow again after getting your initial lump-sum distribution of funds. But you’ll have a predictable payoff timeline and repayment schedule.

 

HELOCs provide more flexibility, but less certainty, especially if you choose a variable-rate loan.

HELOCs vs. cash-out refinance

Is a HELOC or cash-out refinance the best choice? They are very different so you need to understand both options.

 

A HELOC, as mentioned, often has a variable rate. HELOC rates are usually higher than the rate on a cash-out refinance. And the amount you can borrow is determined based on how much equity is in your home and your current loan value.

 

A cash-out refinance, on the other hand, could be a fixed- or variable-rate loan. You will borrow enough with a cash-out refinance to repay your current home loan and give you cash left over. For example, if you owed $50,000 on a home valued at $100,000, you could take a $75,000 cash-out refinance loan. You’d repay the $50,000 and get $25,000 cash to use as you please.

 

Cash-out refis don’t provide the flexibility that HELOCs do since you borrow a fixed amount up front and can’t take any more money out. But you may be able to lower the rate on your current home loan, making payoff cheaper. Interest on your cash-out refi should also be tax deductible regardless of what you use the extra cash for, as long as you itemize on your tax return.

How to find a home equity line of credit

Most of the best mortgage lenders offer home equity lines of credit. When choosing a mortgage lender, get quotes from several loan providers. This could include banks, a credit union, and online lenders. Be sure you’re comparing only fixed-rate loans with other fixed-rate loans and variable-rate loans with other variable-rate loans.

 

You should consider how much the lender allows you to borrow, the timeline your line of credit will be available, qualifying requirements, and interest rate when selecting a HELOC lender.

 

To learn more and determine if a home equity line of credit is right for you, check out our picks for the best HELOC lenders.

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What Is a Home Equity Loan?

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A home equity loan is one of several types of mortgages that allows you to borrow against the value of your home. If you are interested in understanding whether this kind of mortgage is right for you — and what the alternatives are — this guide will help.

What is a home equity loan?

A home equity loan is a secured loan (a loan you get by putting up collateral). In this case, your home serves as collateral to guarantee the debt. Home equity loans are also called second mortgages. You must have equity in your home to apply with one of the best home equity loan lenders.

Home equity loans are paid back on a fixed schedule. You receive a lump sum of money when you borrow, and you repay it on a timeline predetermined with your lender. The repayment period is usually between five and 30 years.

How does a home equity loan work?

You are eligible for a home equity loan only if you have equity in your home. That means your home is worth more than you owe on your current mortgage. If you have sufficient equity, you can apply for a mortgage of this type with a lender offering home equity loans.

Your lender will evaluate your financial credentials. The amount you can borrow and your interest rate is determined based on:

  • How much your home is currently worth;
  • Your income and credit score;
  • The balance on your home loan.

You will find out your interest rate and payoff time up front. Loans with higher rates are more expensive. A longer repayment time also makes your loan more expensive over time since you pay more interest, although each monthly payment is cheaper.

You can use the proceeds from a home equity loan for anything you’d like. The home guarantees the loan, and if you do not make payments, your home equity loan lender can foreclose on your home.

How much can you borrow with a home equity loan?

How much you can borrow with a home equity loan depends on how much you already owe and how much your home is worth.

Most mortgage lenders limit you to borrowing no more than 80% to 85% of what your home is worth. This includes your first mortgage and your home equity loan. Some lenders let you go up to 90%.

To understand this, take a simple example. Say your home is worth $100,000 and you owe $50,000. If you are allowed to borrow a total of 80% of your home’s value across all loans, your maximum combined mortgage amount would be $80,000. Since you already owe $50,000, you would be able to take out a home equity loan for up to $30,000.

Types of home equity loans
Home equity loans can be broadly divided into two types:

  • Fixed-rate home equity loans: These usually have a higher starting interest rate than adjustable-rate home equity loans. The rate is guaranteed for the life of the loan. You will not see rates, payments, or total costs rise.
  • Adjustable-rate home equity loans: These are also called variable-rate home equity loans. They are tied to a financial index, and rates can change periodically. There is a chance your rate could increase, which could make total payoff costs and monthly payments higher.
  • It’s a good idea to check current mortgage interest rates for both fixed- and adjustable-rate home equity loans to decide which is right for you.

  • More on variable rates: A variable-rate loan is much riskier because you take the chance of rates adjusting up — especially if you’re borrowing when rates are low. Be sure you know how high your rates could go before choosing a loan with a variable rate.

What can you use a home equity loan for?

You can use the proceeds of a home equity loan for virtually anything. Many people use home equity loans for consolidating debt. That’s because home equity loans usually have lower interest rates than many other types of loans.

Home equity loans can also be used for home improvement. Home equity loan interest may be tax deductible if you use the proceeds from the loan to buy, build, or substantially improve the home serving as collateral for the loan.

Be aware of the risks
You take a risk when converting unsecured debt (a loan with no collateral), such as credit card debt, to secured debt. Be sure you can make the payments easily before putting your house on the line.

Home equity loan three-day cancellation rule
A three-day cancellation rule applies to home equity loans. This is an important consumer protection rule.

 

Under this rule, you have the right to cancel the transaction until midnight of the third business day after signing the credit contract. The clock starts when you receive a Truth in Lending disclosure providing the details of your loan. Creditors can’t release the money from the loan until the third day has passed.

 

If you choose to cancel the contract, you must provide written notice to the creditor.

 

Home equity loan costs

Home equity loans can come with high upfront fees. They are often called closing costs because they are paid at the time you close on the loan.

 

Home equity loan closing costs usually run between 2% and 5% of the amount borrowed. They include:

  • Appraisal fees
  • Credit report fees
  • Loan origination fees
  • Document preparation fees
  • Attorney fees
  • Title search costs
  • Notary fees

Some lenders allow you to roll these costs into your loan amount. This will mean you are borrowing more. If lenders advertise “no-closing-cost” loans, this is often what’s happening. Some lenders also charge higher rates to cover closing costs in a “no-fee” loan, rather than adding the costs to your loan balance.

Is a home equity loan right for you?

A home equity loan has some significant advantages, but also some disadvantages. Consider the pros and cons of a home equity loan when deciding if it is right for you.

Pros of home equity loans
Here are some of the biggest advantages of home equity loans:

  • You can often borrow at an affordable rate
  • You have the option to choose a fixed-rate loan, which provides certainty in terms of total costs and monthly payments
  • Interest may be tax deductible in some circumstances
  • You have flexibility in what you can use the loan proceeds for
  • You will know your repayment timeline and total payoff costs up front
  • If you know exactly how much you want to borrow and can qualify for an affordable home equity loan, this type of mortgage may be right for you.

Cons of home equity loans
There are also some downsides to home equity loans:

  • You put your home at risk of foreclosure if you don’t make your payments
  • The interest rate is typically higher than with a first mortgage
  • You could end up owing more than your home is worth if you take too much equity out of your home
  • You must know up front how much you want to borrow
  • You must have equity in your home to qualify
  • If you aren’t sure how much you’ll need to borrow or aren’t confident that you’ll be able to make monthly payments, you may want to steer clear of a home equity loan.

Alternatives to home equity loans
Here are some alternatives that also allow you to tap into home equity.

Home equity loans vs. home equity lines of credit
Deciding between a home equity loan or a home equity line of credit (HELOC) can be tricky because both allow you to take out a second loan to access equity in your home.

There are big differences between them though. Here’s what they are:

Home Equity Loan

  • You borrow a set amount
  • You have a set repayment schedule and know total costs
  • Fixed-rate loans are available

HELOC

  • You borrow up to a certain amount (like a credit card); as you pay it back, you can draw from your credit line again
  • Often don't have predictable costs or payoff schedules
  • Most are variable-rate loans (some lenders offer fixed-rate loans)

Home equity loans vs. cash-out refinance
A cash-out refinance loan also allows you to tap into your equity. But it works differently than a home equity loan.

With a cash-out refinance loan, you don’t get a second mortgage. Instead, you take out one new mortgage to pay off your existing home loan — but you also borrow more than you currently owe so you end up with extra cash. For example, if you owe $50,000 on a $100,000 home, you could take out an $80,000 cash-out refi. You’d use $50,000 of the proceeds to repay your current loan and walk away with $30,000.

Cash-out refinance loans can have lower rates than home equity loans and could potentially save you money on your existing home loan. But they make sense only if you can reduce your current loan rate.

How to find a home equity loan lender
Many lenders offer home equity loans. Choosing a mortgage lender can be complicated as a result.

To make it easier, get quotes from several loan providers to find the best mortgage lenders for your situation. When comparing quotes, consider:

  • Qualifying requirements
    How much the lender allows you to borrow
    Options for repayment timelines
    Closing costs and fees
    TIP

Prepare your credit
Improving your credit score before applying for a home equity loan can help you qualify for a better rate. You can improve your score by repaying debt, writing a goodwill letter to ask creditors to remove negative information from your credit report, or asking a loved one with a solid credit history to add you as an authorized user to one of their cards.

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