Is cash-out refinancing or a HELOC loan better for you? Here are the pros and cons (2024)

• What is a cash-out refinance?
• Pros and cons of cash-out refinance
• What is a home equity line of credit?
• Pros and cons of HELOC loans
• Key differences between a HELOC loan and a cash-out refinance
• Bottom Line

Cash-out refinancing allows you to convert your home equity into cash and take out a loan that is larger than your current mortgage.

If your home is worth $500,000 and you have $200,000 left on your mortgage, you could get a cash-out refinance loan for up to the full $500,000. Of that amount, however, $200,000 would go to pay off your existing home loan, leaving you with $300,000 to spend however you want.

Rocket Mortgage Refinance

Ally Home

If you're thinking of a cash-out refinance, you should have a debt-to-income (DTI) ratio of no more than 45%. To determine your DTI, divide your monthly debt payments by your monthly salary and multiply that number by 100.

In addition, you should have paid off at least 20% of your home's value. If your home is worth $500,000, for example, you should have at least $100,000 in home equity.

There may also be restrictions on when you can refinance. FHA and VA mortgages require borrowers to have owned their home for at least 210 days and made six monthly payments before they can refinance.

Here are some of the benefits and drawbacks of refinancing your mortgage.

Pros

• More money. By borrowing based on what you've already put down on your home, you can access a larger amount.
• Lower interest rates. Even if you refinance when rates are higher, chances are they'll be lower than a credit card or personal loan.
• Increase your home's value. The extra cash you get during a refinance can be used for renovations and other home improvements.

Cons

• Higher mortgage rate. You could be paying a higher interest rate on the value of your original mortgage.
• Closing costs. You'll have to pay closing costs on the new mortgage, typically 2% to 5%.
• Foreclosure risk. If you fail to make timely payments on the new loan, you could lose your home.

A home equity line of credit, or HELOC, is a second mortgage that allows you to borrow against your home equity, or the value of your home minus what's left on your mortgage. The funds can be used for whatever you want, but it's not a good idea to take out a HELOC for everyday expenses.

While the amount of equity you can borrow against varies by lender, it's typically capped at 85%.

Homeowners who have paid off their mortgage but need money for a major purchase, to pay off a high-interest debt or to renovate their property could consider a HELOC.

If you have a favorable interest rate on your existing mortgage, a HELOC could also be a good option.

While every borrower's situation is different, there are some pros and cons to taking out a line of credit on your home.

Pros

• Separate from your mortgage. You can continue to pay a lower rate on your first mortgage even if interest rates have risen.
• Lower interest rates. HELOC rates tend to be lower than credit cards or traditional loans.
• Flexibility. You can use the funds as you need them and only have to repay what you spent.

Cons

• You'll have two mortgages. Taking on more debt puts you at higher financial risk.
• Variable rate. If interest rates have risen since you first took out the HELOC, you'll be paying more.
• Higher credit threshold. Most lenders require a credit score of 720 to qualify for a HELOC.

While both loans leverage the value of your home, there are key differences between a HELOC and a cash-out refinance.

It's easier to get a cash-out refinance

While getting a HELOC can require a credit score of up to 720, a refinance loan usually only requires a 620. Some lenders will accept a score of 580.

The interest rate is consistent with a cash-out refinance

HELOC loans are variable, meaning they shift with the marketplace. If interest rates increase, so will your second mortgage.

How the cash is distributed differs

While you get the money from a cash-out refinance in one lump sum, a HELOC allows borrowers to make multiple withdrawals.

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