Comparing Cash-Out Refinance, HELOC, and Home Equity Loans: Which is Right for You?

This guide will help you understand the differences between cash-out refinancing, HELOCs, and home equity loans. We’ll also assist you in determining which option is best suited to your needs.

When you need to finance a home renovation, you have several options. Home improvements can be expensive, and more often than not, homeowners don’t have the personal savings to cover them all in one shot — or would rather not use them . So they look to different loan options to cover the costs. 

Accessing the equity in your home can be a great way to pay for that renovation project. Refinancing your current mortgage could be too. And you may have considered both. If you have, this guide is for you.

If you’re nulling over which is better between a refinance or home equity loan, then you’re in luck. We’re covering the key difference between a cash-out refinance vs a home equity loan and a home equity line of credit vs. a cash out refinance, the pros and cons of each, and how to make the best decision for you.

Comparing Cash-Out Refinance, HELOC, and Home Equity Loans: Which is Right for You?

Contrary to a common misconception, a home equity loan is not the same as refinancing. While both involve using your home’s equity, they each have distinct purposes. A home equity loan is a separate loan, otherwise considered a “second mortgage,” that allows you to borrow against your accumulated home equity, while refinancing replaces your existing mortgage with a new one. We’ll cover other important differences below.  

Cash-Out Refinance vs. Home Equity Loan & HELOC

A cash-out refinance is a type of mortgage that allows you to take on a larger mortgage than what you currently owe in exchange for accessing equity in your home. Instead of a second mortgage with its own monthly payments, it requires you to refinance your existing mortgage to a higher loan amount, and use the difference for home improvements. The process is very much like the one you went through for your primary mortgage, and you can choose to keep the same term length, but this option may come with higher interest rates and fees.

Reversely, a HELOC, or home equity line of credit, will take the form of a second mortgage unless you’ve paid off your first mortgage completely. This type of home equity loan is different from the traditional in that it will function similar to a credit card with a revolving line of credit versus being provided as a lump sum. HELOCS offer an available credit limit based on your home’s value, the amount owed on the mortgage, and your lender’s specific criteria.

A home equity line of credit gives you the flexibility to access more funds as needed during the renovation, otherwise known as the draw phase. This phase typically lasts around 10 years before repayment starts, which is typically a much longer window than other loan options.

But not all home equity loans are HELOCs. While both loan options are secured loans that use your home as collateral and use your home equity to determine your loan amount, a traditional home equity loan has a different interest rate structure and repayment terms.

While a HELOC has variable interest rates that can fluctuate throughout the life of your loan, a home equity loan has a fixed rate, which means it will never change, regardless of the market conditions. And while a HELOC has that delayed repayment phase that starts once the construction/draw phase is over, requiring the homeowner to pay back only what was drawn from the loan amount, home equity loans require the homeowner to start repaying the entire loan amount almost immediately. Credit limits are also typically higher with HELOCs. 

Pros & Cons of Using a Cash-Out Refinance

The Pros:

• With a cash-out refinance, borrowers enjoy one simplified payment per month — instead of a mortgage payment and a separate payment for a home equity loan.
• For homeowners tackling larger projects, a cash-out refinancing allows homeowners to borrow a larger amount of money than a home equity loan.
• As long as your improvements add value to your home, you can deduct the interest you pay on the mortgage come tax time, while increasing your tax basis in your home to help reduce your capital gains tax liability. 

The Cons:

• When you refinance a mortgage, you’ll also have closing costs that can range from 2% to 5% of the loan amount — or up to thousands of dollars in upfront costs.
• Refinancing means that the homeowner is taking on a larger mortgage payment, which can put them at risk of foreclosure if they can’t keep up with the payments.
• With longer repayment terms, a cash-out refi could mean homeowners may end up paying more in interest over the life of the loan.

Expert Tip: While these pros and cons are standard across traditional cash-out refinances, a RenoFi Cash-Out Refinance works a little differently. This new type of home renovation loan allows you to borrow based on your home’s after renovation value. As a result, you’ll be able to borrow the most money with the lowest monthly payment for your renovation — up to 11x more than with a regular cash-out refinance.

And while this type of loan takes that best feature from a traditional construction loan, it doesn’t require funds to be disbursed to contractors through a complex inspection & draw schedule process like these loans do. In fact, it’s the only renovation loan that doesn’t.

Pros & Cons of Using a HELOC

The Pros:

• A HELOC allows the borrower to tap into their credit line only as needed, and only pay interest on the amount they drew (rather than the total in the credit line), which offers a lot more flexibility than most loan alternatives.
• The line of credit remains open until its term ends.
• You get flexibility to borrow as much or as little of that money as you need for your project within your credit limit. 
• Repayment terms are flexible, so you can pay it off quickly or make minimum monthly payments.
• When using a HELOC for a major home improvement that adds value to your home, your interest may be tax-deductible. 

The Cons:

• A HELOC is secured by your home, meaning if you stop making the payments on the loan, the lender could foreclose on your home.

• A HELOC has a variable interest rate, so the minimum payment could increase as interest rates rise. This makes it difficult to budget the overall cost of a HELOC before your project begins.

• During the HELOC’s draw period, you only have to make interest-only, which tends to be small, so when principal repayment begins during the repayment period, this transition can be quite drastic, so budget accordingly.

• Since a HELOC is revocable like a credit card, your ability to access the money isn’t always guaranteed. If your financial situation worsens or your home’s market value declines, your lender could decide to lower your credit line or close it.

• Like with a credit card, you could overspend without discipline.

  Expert Tip: If you’re hesitant to lose your low interest rate by refinancing your home and leaning toward a HELOC to finance your home renovations, consider a RenoFi HELOC. This loan is designed with the same flexibility in accessing your funds on an as-needed basis, but with a lot more borrowing power than a traditional HELOC.
  
  Like all RenoFi loans, you can borrow up to 90% of the after renovation value of your home, which means you’ll be able to get the financing you need to tackle a project of any size — all at the lowest rates available.

Key Differences: Home Equity Loan vs. Cash-Out Refinance

While the importance of your home equity overlaps with both of these loan options, knowing the main differences of a cash-out refinance vs. a home equity loan is what will help you make the best decision for you. Here are some of those key differences:

1. Best use cases: While a cash-out refinance can be used for any purpose, such as consolidating debt or financing an investment property, a HELOC and home equity loans are specifically designed for home improvement projects or other major expenses.
2. Interest rates: Since HELOCs and home equity loans are riskier for lenders, they typically have higher interest rates than cash-out refinance. But the interest rates for each will vary depending on individual factors such as your credit score, home value, and loan amount.
3. Repayment terms: Cash-out refinances typically have longer repayment terms than home equity loans. HELOCs typically have a 10-year draw period requiring you to only pay interest on the amount you draw. Once this draw period ends, you enter a 10 to 20-year repayment period, during which you must pay back the principal amount plus interest. Both home equity loans and cash-out refinances have fixed repayment terms, a home equity loan is much shorter at 5-15 years, whereas cash-out refinances will be as long as 15-30 years, meaning lower monthly payments but higher total interest.
4. Closing costs: Since home equity loans are second mortgages and not a complete refinance of the original mortgage, they generally have lower closing costs than cash-out refinances.
5. Loan amount: HELOCs and home equity loans are typically smaller than cash-out refinances, which can allow for more flexibility in how you use the funds. But factors such as your credit score, income, and home value will determine the amount you can borrow regardless of which you choose.
6. Risks: HELOCs, home equity loans, and cash-out refinance can all be risky as they use your home as collateral. But cash-out refinances also come with additional risks, including resetting the clock on your mortgage and potentially increasing your monthly payments.

Pros & Cons of Using a Home Equity Loan

Similar to a HELOC, a home equity loan uses your home’s equity to determine the amount you’ll be able to borrow. But unlike a HELOC, these funds are provided a lump sum of cash, which is to be paid back based on a fixed interest rate over the span of 5 to 20 years.

When it comes to home renovation loans, home equity loans are some of the best available because they not only have lower interest rates than most alternatives, but they also offer large loan amounts that help homeowners tackle more of their project wishlist in one shot.

The Pros:

• Home equity loans typically offer lower interest rates than unsecured debt, such as credit cards, personal loans, etc.
• You can borrow a substantial amount of money with a home equity loan, which can be useful for homeowner’s tackling major home renovations.
• A home equity loan has a fixed interest rate, meaning that your monthly payments will remain the same over the life of the loan, allowing you to budget more accurately.
• The interest you pay on a home equity loan may be tax-deductible, which can lower your overall tax bill.
• Closing costs and fees tend to be lower than traditional cash-out refinance.

The Cons:

• Since a home equity loan is secured by your home, you could be at risk of foreclosure if you’re unable to make your payments. 
• The fees and closing costs associated with getting a home equity loan will add to the overall cost of the loan.
• Taking on more debt can increase your overall financial burden, but by making timely payments, it can help improve your credit. 

When considering a home equity loan, it’s vital to understand the concept of usable equity. Usable equity refers to the portion of your home’s equity that lenders typically consider available for borrowing based on your loan-to-value ratio. Regardless of the equity you have accrued over time, lenders usually factor in a certain percentage (typically 80%) of this equity as usable.

RenoFi Home Equity Loans allow you to borrow based on what your home’s value will be after your renovation is complete. That means compared to most traditional lenders basing borrowing limits exclusively on loan-to-value-ratio, you’ll have much more usable equity with a RenoFi Loan.

Factors to Consider When Comparing a Cash-Out Refinance vs. Home Equity Loan

When comparing your options of a cash-out refinance vs. home equity loan, your personal situation and goals will play the most important role. Here are some main things to consider as you determine your needs:

• Your Personal Finances. Understanding what you can afford in terms of monthly payments is one of the first steps. Determining if lower monthly payments with a longer repayment term will be valuable for you, or if you would benefit from a delayed repayment with HELOC’s draw period. Also think about if you want all the finances upfront or would prefer the flexibility and have the discipline to access your funds on an as-needed basis.
• Purpose of Funds. A home equity loan or cash-out refinance is a good call if you know exactly how the money will be used. If you’re not sure how much you’ll need to borrow or when exactly you’ll need it, a HELOC gives you access over a period of time.
• Short-Term vs. Long-Term Goals. Understanding your renovation goals will play a major role in budgeting out your project and understanding how much you’ll need. Whether it’s a small remodel or a major renovation that tackles all your wish list items in one shot, figure out how much you’ll need to borrow and how long it will take you to pay it off. A HELOC could be helpful if you’re not exactly sure what those project goals are, but want the flexibility to tackle the projects you want over a longer period of time (10 years). 
• Interest Rate Considerations. Fixed or variable, lower interest payments or lower monthly payments. Once again, think about your personal situation and how each will factor into your financial goals. And think about the market as well. While it can be unpredictable, it helps to understand the type of rate market during the time of your project and what experts predict could be on the horizon. If a variable rate feels too risky, or you simply don’t have the extra funds for potential high fluctuations, then a HELOC isn’t the way to go.
• Tax Implications. If you refinance any mortgage, you can claim the new loan as home acquisition debt up to the principal of the previous loan; anything above that will be considered home equity debt. You can also deduct any points paid over the life of your loan. With a second mortgage, interest is tax deductible on certain occasions. If your home improvements add significant value to your home, these interest payments are often deductible. Understanding these values can make a difference in your budgeting. 

Choosing the Right Option for Your Home Renovations

So which is better: a refinance or home equity loan? If you’re looking for the best home loan to finance your renovation project, it helps to have as much information as possible. HELOC can offer flexibility and potential cost savings, but it also comes with the risks of variable interest rates that can rise over time, so you end up spending more than initially anticipated.

On the reverse side, if you have a lot of equity built up in your home, a cash-out refinance can help you access all the funds you need while qualifying for a lower interest rate than your current mortgage.

All of these factors will depend on the current interest rate market, your specific financial situation, and the specific criteria of your lender. So before anything else, determine your renovation goals and talk to your financial advisor to understand how much you can afford and how that affects your long-term financial goals. Then connect with various lenders and contractors to get quotes and estimates to help you understand which loans are available based on your project costs.

RenoFi can put you in touch with lenders in your areas within our network of trusted Credit Unions, as well as reputable contractors with specialties across a variety of home improvement areas. 

How RenoFi Can Help

RenoFi has a team of expert Renovation Advisors that can help you learn more about your loan options and find the best lenders available to get you started. While we know our loans are the best in terms of getting you the most money for your project at the lowest rates available, we also know how to help you find which type of loan is the right one for you. Plus, our partnerships with several awesome credit unions allow us to offer these lower rates and give you even more flexibility based on your financial situation.

For more information comparing a home equity loan vs. cash-out refinance for your project, or how we can help finance your renovation in the smartest way possible, contact us today!