Renovating Your Home: Choosing Between HELOC and Cash-Out Refinance

Renovating Your Home: Choosing Between HELOC and Cash-Out Refinance

You’ve worked hard and saved up to buy a home. You’ve been paying your mortgage on time each month and are now thinking about doing some home improvements. But your current monthly payments don’t leave a lot of extra cash for something like that. Well, good news!

There are some financing options available that allow you to leverage your home itself and tap into your home equity to get the funding you need. Two of those options are a HELOC and cash out refinance.

For a renovation project, there are a lot of factors to consider when deciding between a HELOC vs. a cash out refi in terms of payment structure, repayment terms, loan amounts, and more.

To help you compare a home equity loan vs. a cash out refinance, it’s important to know the ins and outs of each. Let’s start with some important details about a HELOC, including answers to How much equity do you need for a HELOC? Are there downsides to a HELOC? How long does a HELOC take? And more

This guide, will cover all the pros and cons of a HELOC vs a refinance. We’ll also cover the difference between HELOC and cash-out refinance, how hard it is to get a HELOC, and other important details you need to know. 

HELOC vs. Cash Out Refi 

As your mortgage matures, you gain equity in your home. This equity is your property’s value minus what you currently own on your mortgage. The longer you’ve owned your home and the more you’ve paid down this mortgage, the higher your equity will be. Both cash out refinance vs HELOC options allow you to borrow against the equity you’ve built in your home. So if you have enough equity for a HELOC or cash out refi, they can be two great options to finance your project.

A HELOC stands for “home equity line of credit.” These loans are designed as a revolving line of credit by offering an available credit limit in which you can borrow. This limit is determined by your home’s value, the amount owed on the mortgage, and the lender’s criteria. In contrast, Cash-Out Refinance involves replacing your existing mortgage with a new one, providing you with a lump sum of cash by increasing your mortgage balance, changing your original interest rate.

The difference between HELOC and cash-out refinance is cash out refi involves replacing your current mortgage with a new one, increasing your mortgage balance, and providing you with a lump sum of cash. While a Home Equity Line of Credit (HELOC) functions like a flexible credit card secured by your home’s equity.

Also, HELOCs have variable rates, rather than fixed rates. This means that your interest rates will fluctuate depending on the market (and the prime rate) as you’re paying back your loan.

Expert Tip: One significant advantage of a Home Equity Line of Credit (HELOC) over a Cash-Out Refinance is the flexibility it offers. With a HELOC, you can access your home’s equity as needed, similar to a financial safety net. This flexibility is particularly valuable for projects or expenses with varying costs over time, such as home renovations. Real Estate Guru Jay Costa notes that " a big negative to consider when deciding between HELOC vs cash out refinance is closing costs. There is a big difference HELOC barely has any closing cost, but a cash out refinance has closing cost that are similar to traditional mortgage."

Making the Right Choice for Your Renovation Project

Deciding between a home equity loan vs cash out refinance comes down to a number of key factors, including your specific financial situation and goals. Before you apply for a mortgage, consider all the benefits and downsides of a HELOC vs cash out refi when financing your renovations.

Still not sure on your choice?

RenoFi can help you compare your lender options and even help you qualify for a RenoFi HELOC or Cash-out Refinance for you next home improvement project - click the button below.

Side-by-Side Comparison: HELOC vs Refinance

The Verdict: Whether to Use a HELOC or Cash Out Refi for Your Home Renovations

When it comes down to it, only you can make the final decision in regard to whether you should use a HELOC or cash out refi. It’s so important to be as informed as possible before making a decision that best suits your unique renovation goals. And at RenoFi, we’re here to help - click the button below.

Here’s a final recap of a Cash Out Refinance vs. HELOC to help you take the next steps toward getting the financing you need.

• Qualifying: Since cash out refis tend to be less risky for lenders, they often have lower qualifying standards than HELOCs, making them more accessible to more people. But if you have a great credit score and have built up a lot of equity in your home, are financing renovations that will increase the value of your home, then you should be in good shape. 
• Interest Rates: Interest rates with a cash out refi are typically the lowest rates available. And with a fixed rate structure, you won’t have to worry about them fluctuating throughout the life of your loan.
• Repayment: With a cash out refinance, repayment on your principal loan amount and interest begins as soon as you receive your full loan amount up front. With a HELOC, you have a 10-year draw period where you will only pay interest on the amount you’ve withdrawn, and then pay the principal + interest over the course of 10-20 years once your draw period ends.
• Tax Deductions: Both cash out refinances and HELOCs may qualify as deductions come tax season.
• Additional Fees: A cash out refi will require you to pay closing costs once you refinance your mortgage. While a HELOC typically has little to no closing costs, you will be paying your monthly loan payments on top of your current mortgage payments. And if you close your loan early, you may also have to pay a termination fee.

Why RenoFi Fixed Rate HELOCs Are The Safest Choice

If you have enough equity for a HELOC and want flexibility in your funding with a long repayment period, there’s an even better option than the traditional HELOC on the market.

RenoFi has a fixed rate HELOC not only gets you all the perks of a traditional HELOC, but also the fixed rate feature of a cash out refi. This way you won’t have to worry about your interest rates changing and owing more than you expected when all is said and done.

But it gets even better. With a RenoFi HELOC, you can borrow against the after revocation value of your home versus its current value. This allows you to significantly boost your borrowing power and get enough financing to cover all the improvements on your renovation wish list.

If you want to learn more about how a HELOC vs cash out refi compares for your specific financial and renovation needs, or why the RenoFi HELOC is the smartest way to access the max loan value for a HELOC, contact our Renovation Advisors today. Or subscribe to our newsletter to get the latest financial insights and tips to help guide your home renovation.

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What you need to know about using a HELOC

There are a few requirements you should know to help you understand how to qualify for a HELOC. Each lender will be different, but the main criteria includes:

• At least 15-20% equity built up in your home. 
• A credit score of mid-to-high 600s (700+ is even better)
• Sufficient documentation, including proof of income, social security benefits, etc. 
• On-time payment history  
• A debt-to-income ratio of no higher than 43-50%

Do you need an appraisal for a HELOC?

Yes, lenders will also typically require borrowers to get an appraisal on their home to ensure a proper valuation that they’ll use to determine your loan amount. But who pays for an appraisal for a HELOC? While every lender will handle HELOC appraisals differently in terms of choosing the type of appraisal and scheduling it, you will be responsible to pay an appraisal fee as part of your loan costs at closing. 

How long does a HELOC take?

Applying and obtaining a HELOC usually takes about two to six weeks. But that all depends on how quickly the borrower (aka you) can provide the lender with the required documentation. Then there’s the lender’s underwriting and HELOC processing time to follow. 

Can you pay a HELOC off early?

The short answer is yes. HELOCs generally have two phases: the draw phase and the repayment phase. The draw phase generally lasts around 10 years, and this is when you can use your line of credit whenever you’d like. During this phase you’ll also only be required to pay interest on the loan, and once it ends, you’ll enter the repayment period, which is typically 10-20 years.

You can choose to start paying back the principal loan amount during the draw phase to help you get a jump start on repayment or make the transition to principal payments less drastic. BUT if you ask your lender if you can pay a HELOC off early, they’ll most likely have assessed fees; the most common is an early repayment penalty, which applies to paying off and closing your HELOC within the first few years. 

Can I use my HELOC money for anything?

As long as you have enough equity in your home and meet your lender’s requirements, you can use your HELOC for just about anything. The flexibility these loans offer are one of the best perks. But they are best suited for long-term, ongoing expenses such as home renovations or medical bills.

Whether or not you should use a HELOC or cash for another major expense depends on your circumstances. That’s because similar to a credit card, having access to money you don’t technically have can make it easy to overspend. In other words, these loans aren’t great for frivolous purchases as it’s easier to end up owing more than you expected, especially as interest rates change. We recommend not to use a HELOC for the following:

• Vacation
• Buying a Car 
• Investing in Real Estate 
• Credit Card Debt (it will likely only compound what you already owe)

HELOC Pros vs Cons

Let’s talk about some of the benefits of a HELOC?

• Flexibility: HELOCs allow you to tap into your credit line on an as-needed basis versus providing everything in a lump sum upfront. This gives you more flexibility in how you use your money and how much you actually use — and pay interest on. Repayment terms are also flexible. You can choose to pay it off or make minimum monthly payments/
• Interest Payments Only: While your credit line is open, you are only responsible for paying interest on the loan. This can help borrowers better budget their spending with more time to plan for the repayment period.
• Potential Tax Benefits: The interest on your HELOC may be tax deductible when used for a major home improvement project. Consult your tax advisor.

The biggest advantage of using a home equity line of credit is the flexibility to access more funds as you need it (during your renovation), and a longer window to start repayment. 

Are there downsides to a HELOC?

Just like any home loan, there are some things to consider before choosing which is best for your renovation. 

• Variable Interest Rates: Your minimum payment can fluctuate as interest rates rise throughout the life of your loan. This means there’s the potential to pay back more than you expected from your lender.
• Qualification Requirements: Each lender will have different requirements for how to qualify for a HELOC, but typically this criteria will be tougher than most other renovation loans options.
• Repayment Terms: While you only have to pay interest during the draw period, if your financial situation worsens or the housing market declines, your lender could lower your credit line, or even close it. And once you do reach the repayment period, anticipate substantially higher monthly payments. The transition can be drastic, so budget accordingly. 

The Ins and Outs of a Refinance Loan

Cash-out refinancing involves refinancing your existing mortgage and taking out a larger loan than you currently owe in exchange for accessing equity in your home. The extra cash can then be used to fund your home renovations.

Instead of a second mortgage, which requires you to take out a second loan with its own monthly payments, a cash out refi has you paying off the existing mortgage with a new one. This process requires you to refinance your current mortgage to a higher loan amount, which could increase your monthly payment. However, it may still be lower than the rate of a HELOC or home equity loan.

How Does a Cash Out Refi Work?

Whenever you refinance, you’re starting from scratch with a new mortgage and new terms. Many people refinance to change their interest rate or mortgage term, but with a cash out refinance, you get a new loan that’s larger than your current mortgage balance. This difference then becomes your new loan amount, and what’s owed is what you “cash out” from it.

How much cash you can access depends on your equity, which is how much your home is worth compared to how much you owe. Lenders typically require you to have 20% equity in your home, and allow you to borrow up to 80% of your home’s value.

Does a Cash Out Refi Require an Appraisal?

Yes, your lender will require a professional appraisal to determine your home’s current value. And similar to who pays for an appraisal for a HELOC, the borrower (aka you) will be responsible for those fees, which will be included in your loan closing costs.

Do you pay taxes on a cash-out refinance?

No, you do not pay taxes on a cash-out refinance. Since the money you receive from your cash out refinance is essentially a loan you are taking out against your home’s equity, they are not considered income and are not taxed. 

Factors to Assess When Considering Cash Out Refinance

While interest rates are not higher for a cash out refi, there may be some other fees to consider when choosing between a cash out refinance vs a HELOC. So what is the negative to a cash-out refinance? Here are a few:

1. Closing Costs: Just like with your first mortgage, you’ll have to pay closing costs for your refinance, which you can either roll them into your loan or pay upfront. These fees can total thousands of dollars.
2. Loan-Term and Monthly Payments: Similar to how you could have a lower interest rate thanks to your refinance, you may also have a higher one — depending on the current market. Not to mention, a longer term means more interest over time. Since you’re borrowing more than what you owe on your initial mortgage, your monthly payments may be larger in general depending on this interest and loan term.
3. Equity Requirements and Loan-to-Value (LTV) Ratio: Your LTV is a percentage that compares the amount of your mortgage to the market value of your home. It is one of the most important factors your lender will use when refinancing as it establishes your maximum borrowing limit. If your LTV isn’t strong, it can increase your rates and require mortgage insurance premiums to be paid. 

When is a Cash-Out Refi Better than a HELOC?

There are several advantages to choosing a cash out refi over a HELOC. Here are the biggest differentiators of a cash out refinance vs HELOC:

• Potential for Lower Interest Rates: Your mortgage rate depends on a number of factors, including economic and market conditions, as well as your financial situation. Depending on when you purchased your current home and what the rates are at the time of your loan, you could refinance into a lower rate, which would mean significant savings over the life of your loan.
• Fixed Interest Rates: Once you’re locked into an interest rate with your cash out refi, that monthly payment will never change, allowing you to better budget your expenses.
• Tax-Deductible Interest: You may be able to write off interest for the balance you cash out if the money used for your renovation increases your home’s value. And no, you won’t pay capital gains on cash-out refinance either.

Things to Consider with a HELOC vs. Cash Out Refinance

What is the key difference between a HELOC and Cash-Out Refinance when it comes to renovating? There are four main components to consider:

1. Interest Rates and Long-Term Cost Analysis: In an overall cost analysis, you have to consider a few things. The first being if interest rates are higher for a cash-out refinance or a HELOC. Typically, due to their riskier nature, HELOCs will have higher interest rates, but you may need to pay higher upfront fees for a cash out refi. And the longer your repayment window, the longer you’ll be paying interest, so consider that when budgeting as well. Compare all the fees involved with each. There will be some similarities between the two, such as you won’t pay capital gains on a cash-out refinance or HELOC, but mortgage insurance premiums, closing costs, etc. will add up differently for each.
2.  Flexibility of Fund Access: While some may think the lump sum payout of a cash-out refi is better than a HELOC’s draw period, others prefer the flexibility a HELOC provides since you can access your funds on an as-needed basis. If you aren’t sure exactly how much you’ll need for your project or want more control over your funds, some homeowners find it super helpful to get a HELOC just in case their project plans change significantly along the way.
3. Short vs. Long-Term Financial Goals: Ask yourself the purpose of the loan. If you know exactly how much you need, a cash out refi gives you exactly that all upfront. But one of the biggest advantages of a HELOC is its delayed repayment period. For many people wanting to do home improvements, while still having to pay their monthly mortgage payments, this can be a huge help. And consider the potential long-term implications of fixed versus variable interest rates. If you want stable, predictable payments over the life of your loan, a cash out refi is the way to go. Lastly, the one negative to a cash-out refinance is that you will have to pay closing costs again since you are refinancing on your current mortgage.
4. Qualification Criteria: When it comes to applying for your loan, cash out refis tend to have more lenient requirements. While a HELOC will typically like to see a credit score in the mid to high 600’s, a cash out refi will often only require 580 and above. Your debt-to-income ratio (DTI) for a HELOC also has to be lower than 50% compared to 43% a cash out refi.

The different pros and cons of a HELOC vs Refinance will weigh differently for every borrow. Think about which components of each loan make the most sense to you.

Seeking Expert Advice and Consultation When Deciding Cash Out Refinance vs HELOC

Choosing the right financing for your renovation project is a big decision, so seeking help from professionals can help ensure you have all the information and guidance you need every step of the way. Talk to different mortgage lenders to compare quotes and terms. Find out if their interest rates are higher for a cash-out refi or a HELOC, their specific requirements for the max loan to value for a HELOC vs. a cash out refi, and how much equity you need for a HELOC to make it work for your project goals. 

Then chat with your financial advisor to better understand what you can and cannot afford when comparing a HELOC vs. a cash out refi. They’ll help you figure out how your personal finances and goals for the future will play into your decision as you compare all your loan options.

RenoFi’s team of Renovation Advisors can also help you throughout the process in terms of making sure you have all the proper documentation to apply, what you need for an appraisal for a HELOC or a cash out refi, and even finding the right contractor for the job.