Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Thursday, June 30, 2022

HELOC vs Cash Out Refinance

The following blog post was written by our interns, Mauria Ferrell and Brady Gray in response to a question we received on a recent Money Talks show. You can listen to the episode here

If you need money to consolidate debt or for any other financial goals, there are ways you can access money from the value of your home. Two of the most common ways to pull equity out of your home are through a home equity line of credit (HELOC) or through a cash out refinance. 

A home equity line of credit or HELOC is a line of credit that is tied to your home as the second loan on the property. You are able to take the money out as needed. Think of it as an on-demand loan. HELOCs often come with a floating interest rate tied to the prime rate plus whatever the bank is charging. This could pose an issue for some borrowers as your monthly payment will almost always be different. 

HELOCs work similarly to a credit card by letting you borrow as much as you need, whenever you need it, as long as you do not exceed the set limit. Most banks loan up to 89.99% of the value of the property minus any existing loans. Be sure to shop around at different banks because HELOCs often come with different terms based on the lender. Banks have different borrowing terms, usually around 60 months for HELOCs. When the term is up, you can pay off the loan completely or apply for a new HELOC. 

It is important to remember that this is by no means a conventional mortgage. Lenders have discretion on who they loan to but there is a general criteria that borrowers must meet. Some common requirements are a credit score of at least 700, and a debt-to-income ratio that is under 45%.

When using a cash out refinance, you are refinancing your home to free the equity you have already paid into the home. In this process, you would take out a new mortgage to replace your current mortgage. Let’s take a $500,000 home that has a remaining mortgage balance of $250,000 as an example. You could do a cash out refinance for $400,000 paying off the old mortgage and leaving $150,000 in your pocket. 

Applying for a cash out refinance may be a little harder than getting a HELOC because you are getting a new mortgage instead of a second mortgage. Applicants should have a debt-to-income ratio of 36% or less and have a credit score of no less than 700 and as it increases you will get a better interest rate. Also, it is important that you need to have at least 20% equity in the home to qualify. This type of home equity loan offers fixed interest rates and longer terms creating an easier payback schedule. Keep in mind that closing costs are higher for cash out refinances. 

Deciding which loan is better for you can be hard. Home equity line of credit (HELOC) is a second mortgage that requires an additional monthly payment. Banks are usually more lenient because it won't require appraisal under a certain amount. Cash out refinance replaces your original mortgage with a new loan that is greater than what you currently owe. Interest rates for cash out refinance are typically higher than HELOC because with cash out refinance you are paying back more interest. 

Keep in mind that all banks are going to have different requirements and terms, so be sure to find the option that works best for you. Also, consult a financial advisor to see what fits your needs!