Need help using your home equity? Read this comprehensive guide comparing HELOCs and cash-out refinances to make informed decisions.
Your home equity can be a powerful tool. Sure, it can help you buy a new house when the time comes to sell your existing property, but you don’t have to wait until the sale is finalized to begin using this equity to fund your future –– be it as a means of investing in a business, eliminating high-interest debts, tackling costly home renovation projects, or alleviating some of the pressures of inflation.
There are several ways to access this home equity, with a home equity line of credit (HELOC) and cash-out refinance being two of the most prevalent among homeowners.1 But while these methods achieve similar goals, you’ll want to be sure you understand the fine details of each before you access your home equity.
Explore the ins and outs of HELOCs and cash-out refinances, answering common questions about each to help you make the right decision when unlocking your home equity.
It might be fair to say that a HELOC and cash-out refinance have more in common than they do differences, but how they differ can have a huge impact on homeowners. With that said, let’s start with the similarities between a HELOC vs. refinance before diving into their differences.
Cash-out refinances and HELOCs are both means of unlocking home equity, giving homeowners the freedom to pay off debts, reinvest in the property, or spend this cash in any way they see fit. Each mechanism carries interest rates in exchange for this home equity loan and generally requires homeowners to meet certain credit, debt-to-income, and equity ownership requirements.
Though they might share fundamental similarities, the differences between a HELOC and a cash-out refinance are worth noting. For starters, cash-out refinances allow homeowners to pay off their existing mortgage using a new, larger mortgage loan amount, whereas HELOCs let homeowners draw from available home equity in the same way one might use a credit card. This means, while your monthly payment may increase, a cash-out refinance is still technically your first mortgage. A home equity line of credit, on the other hand, adds another monthly payment to your existing mortgage.
Further, if you pursue a cash-out refinance, your updated monthly payment will arrive almost immediately. This is in contrast to a HELOC loan, which incurs an interest-only monthly payment during the draw period, then a payment for interest and principal once this draw period has closed.2 This can catch some homeowners by surprise, who grow accustomed to making smaller, interest-only payments –– before being blindsided by a marginally larger monthly bill when this draw period closes.
See related: Using a HELOC to Pay Off Your Mortgage
HELOCs are great for some homeowners who need quick access to cash but don’t want to fundamentally alter the terms of their mortgage rates as is the case with a cash-out refinance. With that in mind, HELOCs are not without their share of limitations, the most notable of which are outlined below.
While cash-out refinances are primarily fixed-rate mortgages –– meaning interest rates remain the same for the duration of the loan –– HELOCs are generally variable. This means that the interest rate can fluctuate during the term, creating unpredictability that many borrowers may not be prepared for.
Cash-out refinances allow homeowners to access home equity in a single lump sum, whereas HELOCs allow borrowers to “withdraw” equity as needed over the course of the draw period. For disciplined homeowners, this can mean only the equity that is needed is unlocked. But for others, this can look like a never-ending piggy bank. Because of this, homeowners should be honest with themselves about spending habits before pursuing a HELOC.
One of the biggest downsides of a HELOC is that a home equity line of credit is a secured loan, meaning your home acts as collateral for the loan. If you borrow too much, then get hit with an interest rate hike –– then have to start paying toward the full loan amount –– and can no longer afford the monthly payment, you will face a real issue.
Homeowners aren’t the only ones taking note of the potential risks of a HELOC. Banks, too, have taken a step back from offering home equity lines of credit in the wake of COVID-19, blaming the decision on the economic uncertainty that followed.3 Still, while the risks are well-reported and worth noting, HELOCs can still be quite beneficial to the right borrower.
Some of the banks still offering HELOCs include:
HELOCs and cash-out refinances, while among the most popular ways to unlock home equity, are far from the only options. If you’re not ready to refinance –– but not open to the risks of a HELOC –– here are some tips on how to get equity out of your home without refinancing.
Also known as a second mortgage, a home equity loan allows you to borrow against your home equity — accessing a portion of your available equity, but rarely all of it. A home equity loan shares many of the same restrictions as a cash-out refinance, including credit and equity requirements. When comparing HELOC vs. home equity loans, similarities and differences are also apparent.
Ultimately, some homeowners may find that the best way to access their home equity is by selling the home outright –– using the equity to purchase a larger home, or downsizing and pocketing the profit. For those who may fear variable interest rates and a larger monthly payment, this can be a great way to get debt-free.
Cash-out refinances, HELOCs, and home equity loans all allow homeowners to borrow against their home equity, but Truehold’s sell and stay transaction lets homeowners unlock this home equity debt-free. Instead, homeowners can continue to stay in their homes while paying rent, leveraging their newly unlocked home equity however they'd like. So if you’re looking to free up your home equity without paying hefty interest rates in return, Truehold’s sell and stay transaction might be the best way to do so.
For more information on accessing home equity from the Truehold team, you can pay a visit to our expansive resource library.
Sources:
1. The Washington Post. Cash-out refinancing and HELOCs are expected to surge in 2022. But are they right for you? https://www.washingtonpost.com/business/2022/02/24/cash-out-refinancing-helocs-are-expected-surge-2022-are-they-right-you/
2. Bankrate. What is the draw period on a HELOC and how does it work? https://www.bankrate.com/home-equity/heloc-refinance-draw-period-ends/
3. Investopedia. Some Big Banks Don’t Offer Reverse Mortgage and HELOCs. https://www.investopedia.com/why-big-banks-do-not-offer-reverse-mortgages-helocs-5235647
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