HELOCs work in many ways, much like credit cards. The lender gives you a line of credit, based on the value of your home's equity, and you can take cash from this credit line up to a maximum limit, whenever you need it. You can take out money from a HELOC more than once, and you generally aren't required to take out a specific amount at specific times, although you may be charged fees if you don't make minimum withdrawals. Like credit cards, HELOCs give you an available line of credit to use when you need it. Home equity lines of credit typically have long "draw periods," which are lengths of time that the money in a HELOC is available to you. For example, many HELOCs have draw periods of 10 years, which means that you can take money from the credit line over the course of 10 years. HELOCs usually have adjustable interest rates. This means that the amount of money the lender charges you for interest can rise or fall.

Web Content Viewer

Cash Out Refinance vs. HELOC: Which is Right for You?

Q: What Is a Cash Out Refinance?

When you get a cash out refinance, you’ll get a new mortgage. You’ll pay off your current mortgage and replace it with a new one for a higher amount, taking out the difference in cash as a lump sum at closing. You'll get all the money at one time with a cash out refinance, and you cannot get additional money in the future from the loan. Since a cash out refinance involves getting a new mortgage, you will need to complete a new application, document your current finances, and pay a new set of closing costs. Cash out refinances can be good choices if you know how much money you’ll need. If you want to consolidate higher-interest debts and loan payments, for instance, you might choose a cash out refinance. If you’re planning to complete home renovations and improvements, and know how much they will cost, you might also choose a cash out refinance. You may pay for college with cash out refinances, too.

Q: What Is a Home Equity Loan?

A home equity loan is a second mortgage that allows you to borrow money against the value of your home's equity. With this type of loan, you'll get the money as a lump sum and cannot get additional money from the loan in the future. Home equity loans typically have a fixed interest rate, which means your interest and principal payments will stay the same each month. You can use the money from a home equity loan and a cash out refinance in similar ways. A difference between these two choices is that you cannot change the terms of your current mortgage when you get a home equity loan. A home equity loan is a separate, second mortgage with its own interest rate and its own terms.

Before You Tap Your Equity, Decide Which Loan Option Is Right for You

Your home is often considered your biggest asset because you can access your home’s equity to do things like pay for college, get cash for home improvements, or consolidate high-interest debt. By borrowing against the value of your home's equity, you can get cash when you need it.

There are two main ways to do this: a cash out refinance or home equity line of credit (HELOC). A cash out refinance replaces your current mortgage with a new mortgage for a higher amount, meaning you’ll get the difference in cash at closing. On the other hand, a HELOC works similarly to a credit card, using your home’s equity to borrow up to a set amount. Let’s look at the advantages and disadvantages of both these loans to help you choose the right one for your needs.

At a Glance: Cash Out Refi vs. HELOC Key Differences

	Cash Out Refinance	HELOC
How You Get the Funds	Single lump-sum cash payout after you replace your current mortgage with a new, larger one.	Funds are accessed as a revolving line of credit that you can borrow from.
Interest Rates	Your new mortgage is subject to current interest rates, meaning your overall borrowing costs could increase or decrease.	Rates are higher since a HELOC is a second mortgage and generally riskier for lenders. The HELOC rate only applies to the money you borrow and not your existing mortgage and rate.
Repayment Period	15 or 30 years depending on your new mortgage. The clock on your mortgage term usually resets from the beginning.	There are two distinct repayment periods: the draw period (typically 5-10 years) where you can access funds, and the repayment period (10-20 years).
Loan Structure	Replaces your current mortgage with a new one.	Is a second mortgage with its own fees and interest rate.
Upfront Costs	Closing costs of the new loan, typically 2-6%. An appraisal is usually required.	Fewer upfront costs, but interest rates will likely be higher. An appraisal is usually required.
What It’s Best For	Accessing a large sum of cash and securing a lower, fixed interest rate.	Flexible access to funds for projects where costs are uncertain; avoids replacing your current mortgage.

What Is a Cash Out Refinance and How Does It Work?

A cash out refinance is a type of mortgage refinancing that allows you to replace your primary mortgage with a new, larger one and take the difference in cash. Homeowners typically use a cash out refinance to access the equity they’ve built up on their property for things like home improvements, debt consolidation, or other major expenses.

To get a cash out refinance, you’ll have to apply for a new loan that is larger than your current mortgage balance, and this new loan will pay off your existing mortgage. Then, you’ll receive the difference in cash at closing. For example, if your current mortgage balance is $250,000 and you apply for a new $300,000 loan, you’ll receive the difference of $50,000 at closing (minus closing costs). You’ll then begin repaying your new loan. Cash out refinancing can be a good choice if you know exactly how much money you need.

Cash Out Refinance Requirements

Here are the typical requirements involved in a cash out refinance:

Sufficient home equity: Most lenders require you to retain at least 20% equity in your home after a refinance, meaning that you can usually borrow up to 80% of your home’s appraised value. For example, if your home is worth $350,000, 80% of that is $280,000, meaning that if you owed $250,000, you could cash out around $30,000.
Credit score: Many lenders require a minimum credit score of 620 for conventional refinances. At Freedom Mortgage, we’ve been able to accept as low as 550 for FHA and VA refinances. However, the higher your credit score is, the better the interest rate on your new loan will be.
Debt-to-income ratio (DTI): Your monthly debt payments, including your new mortgage, should generally be below 43-50% of your gross monthly income. The lower your DTI is, the better chances you have for approval and the better your terms will be.
Income and employment history: Lenders typically look for steady income and employment history over the past two years.
Home appraisal: A new home appraisal is required to determine your home’s current market value and ensure there’s enough equity to support the cash out refinance.
Seasoning requirement: Typically, you must have owned the home for at least six months or have made at least six consecutive payments on your current loan.

Now that we’ve touched on the requirements, let’s look at some of the pros and cons of a cash out refinance.

Pros of a Cash Out Refinance:

Here are the major advantages of a cash out refinance:

You'll get all the cash at closing.
You'll make one payment on one loan.
You can change other terms of your mortgage, like your interest rate.
The interest you'll pay may be tax deductible (consult with a tax professional).
Your interest payments won't change if you get a fixed-rate mortgage.

Cons of a Cash Out Refinance:

Here are the major disadvantages of a cash out refinance:

Fixed interest rates might be higher than the adjustable rates on HELOCs.
You'll need to complete a new application and pay new closing costs.
You must begin paying back the loan immediately.
Your repayment period may reset since you took out a new loan.

Since we’ve looked at the pros and cons of both cash out refinances and HELOCs, let’s explore how to choose the right one for you.

What Is a HELOC and How Does It Work?

A HELOC is a type of loan that allows you to borrow from your available home equity. It functions similarly to a credit card, offering a revolving line of credit you can draw from as needed up to a certain limit. Unlike your original mortgage, a HELOC is a second mortgage that gives you flexible access to funds over a set draw period, typically 5-10 years.

During the draw period, borrowers usually make interest-only payments, which keeps monthly costs lower. However, once this period ends, the repayment period begins for both the principal and interest of the loan, and the monthly payments will be higher. Since the loan is secured by your home, failing to repay the HELOC could put your property at risk.

HELOCs are a popular option when it comes to needing flexibility. You can use money from a HELOC to make home improvements or pay for tuition and other expenses when you don’t know exactly how much money you’ll end up needing. Borrowing against your equity is a smart way to gain access to cash when you don’t have it.

HELOC Requirements

Here are the typical requirements involved in a HELOC:

Sufficient home equity: Most lenders allow you to borrow up to 85%-90% of your home’s appraised value, minus your current mortgage balance. For example, if your home is worth $350,000, 90% of that is $315,000, meaning that if your mortgage balance was $250,000, your potential HELOC limit could be $65,000.
Credit score: Some lenders can accept a minimum score of 620 for a HELOC, but they usually look for a score in the upper 600s. For the best rates and higher borrowing limits, a score of 700+ is preferred.
Debt-to-income ratio (DTI): Your monthly debt payments, including your new mortgage, should generally be below 43-50% of your gross monthly income. The lower your DTI is, the better chances you have for approval and the better your terms will be.
Income and employment history: Lenders typically look for steady income and employment history over the past two years.
Home appraisal: A new home appraisal is usually required to determine your home’s current market value.
Minimum draw amount: Some lenders require a minimum initial draw amount at closing (i.e., you’d take out $10,000 to begin the draw period).

Now that we’ve touched on the requirements, let’s look at some of the pros and cons of a HELOC.

Pros of a HELOC

Here are the major advantages of a HELOC:

Flexibility on how much money you take out and when you take it.
Adjustable interest rates, which could be lower than fixed-rate refinances or loans.
Possible flexible, interest-only payments during the draw period.
Potential waived fees or closing costs.
Potentially tax-deductible interest (consult with a tax professional).

Cons of a HELOC

Here are the major disadvantages of a HELOC:

Potentially rising interest rates (could make your payments higher).
A dip in home value could equal a lowering of your maximum credit limit.
Potential fees and charges if you don't end up drawing money from your HELOC.
Paying off a HELOC may be more difficult if you get used to interest-only payments during the draw period, as payments will increase during the repayment period.

Now that we’ve covered HELOCs, let’s learn more about cash out refinances and how they work.

HELOC or Cash Out Refi: How To Choose

Your needs and goals are ultimately what will help you decide between a HELOC or cash out refinance:

Get a HELOC if you…

Want to access cash without getting a new mortgage.
Need flexible borrowing for unknown expenses or emergencies.
Want lower upfront costs (some lenders offer no closing costs in exchange for a higher interest rate).

Get a cash out refinance if you…

Know exactly how much money you need.
Want to secure a fixed interest rate.
Want to consolidate your debts.
Have a large, one-time expense you need to pay.

These key differences can help you understand which option best fits your situation.

Freedom Mortgage Can Help You Access Your Equity

Freedom Mortgage offers HELOCs and cash out refinances on conventional, VA, and FHA loans. Depending on the type of mortgage you currently have and how much equity your home has grown, we can help you tap into that equity.

The standards you'll need to meet to qualify for a cash out refinance or HELOC can vary from lender to lender, and the fees and interest rates can vary, too. Research your options and choose the one that's right for your needs.

Final Thoughts on HELOCs vs. Cash Out Refinances

Ultimately, the biggest difference between a HELOC and a cash out refinance lies in how you access your home’s equity. A HELOC offers flexible, revolving credit with lower upfront costs, while a cash out refinance provides a lump sum of cash and replaces your current mortgage. Understanding these key differences can help you choose the right option for your financial goals. Get started with a HELOC or cash out refinance with us at Freedom Mortgage today.