HELOC vs. cash-out refinance: which is better for you?

What are the ways to borrow against your home?

All three options use your home as collateral (security the lender can claim if you don't repay). They differ in how you get the money, how the rate works and what happens to your current mortgage.

• Cash-out refinance. You replace your current mortgage with a new, bigger one. You get the difference in cash at closing. You end up with one loan and one payment.
• Home equity line of credit (HELOC). A line of credit you can use again and again. It's usually a second lien, meaning a second loan behind your first mortgage. The CFPB (Consumer Financial Protection Bureau) says it works a lot like a credit card: you can borrow, repay and borrow again up to your limit during the draw period.
• Home equity loan. Also usually a second lien. But you get the full amount at once and pay it back on a set schedule. The CFPB says it may have a fixed or adjustable rate.

Will a cash-out refinance change my current mortgage rate?

Yes. A cash-out refinance pays off your current mortgage. Your whole balance, not just the new cash, moves to whatever rate is available the day you lock.

A HELOC or home equity loan leaves your first mortgage alone. If you have a rate you love, keeping it and adding a smaller second loan can make more sense than refinancing the whole balance.

It works the other way, too. If today's rates are close to or below your current rate, or you want everything in one fixed payment, a cash-out refinance may be simpler. That's why I always compare the blended cost (your first mortgage plus a second loan, together) against the cost of one new loan.

Is a HELOC rate fixed or variable?

The CFPB notes that HELOCs usually have variable rates. That means your payment can change as rates move and as your balance changes. Some plans let you switch all or part of the balance to a fixed rate. That fixed rate is usually higher, in exchange for a steady payment.

A HELOC usually has two phases:

1. Draw period. You can borrow up to your limit. The CFPB gives about 10 years as an example. Many plans require only a minimum monthly payment during this time.
2. Repayment period. You can't borrow anymore, and you pay off the balance on a schedule, often 10 to 20 years per the CFPB. Payments can jump a lot when this phase starts. Some plans require the full balance at that point.

A cash-out refinance can be fixed-rate or adjustable. A home equity loan has a set payment schedule from day one. If a predictable payment matters most to you, keep that difference in mind.

What are the closing costs for a HELOC vs. a cash-out refinance?

A cash-out refinance is a full new first mortgage. So you'll usually see the full set of closing costs: appraisal, title and closing services, lender fees and prepaid items. Those costs are spread over a bigger loan, but they're real dollars either way.

HELOC and home equity loan costs vary a lot by lender. Some charge lower upfront costs. Some have annual fees, minimum draw rules or fees if you close the line early. The CFPB recommends asking about every fee before you sign. I'd compare the Loan Estimate or HELOC disclosures line by line instead of trusting a headline.

HELOC vs. home equity loan vs. cash-out refinance: side by side

Can I cancel a HELOC or cash-out refinance after closing?

Often, yes. Federal Truth in Lending rules (Regulation Z) give you a right of rescission, which is a right to cancel. It applies to many loans secured by your principal dwelling (the home you live in). That includes most cash-out refinances with a new lender, HELOCs and home equity loans.

You can cancel until midnight of the third business day after the latest of these: closing, getting the rescission notice, or getting all required disclosures.

For this rule, "business day" means every day except Sundays and federal holidays. Saturdays count. That's why the money on these loans usually isn't paid out until the cancel period has passed.

A few points people miss:

• Purchase loans can't be canceled this way.
• A refinance with the same lender is generally exempt, except to the extent the new loan amount is more than the old balance plus certain costs. In other words, the new cash part is still covered.
• The rule applies to your principal dwelling, not to second homes or investment properties.

What are the risks of borrowing against your home?

HELOCs have one more risk. The CFPB notes that a lender may freeze or lower your line if your home's value drops a lot or your finances change. If you're counting on that line to finish a project, plan for that.

I also ask clients to be careful about using home equity to pay off credit cards or other unsecured debt. It can lower your monthly cost. But it turns credit card balances into debt backed by your house. That trade deserves an honest conversation, not a quick yes.

Is HELOC interest tax deductible?

Only in some cases. IRS Publication 936 says interest on home equity loans and lines of credit is deductible only if the money is used to buy, build or substantially improve the home that secures the loan, along with other limits. How it applies to you depends on your situation, so please talk with a tax professional. I'm a loan officer, not a tax advisor.

If you'd like me to compare a HELOC, a home equity loan and a cash-out refinance against your current mortgage, send me a note. Every option is subject to credit approval, program guidelines and property eligibility.

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