There are many ways to tap your home’s equity and convert it into cash. And these three loan options – HEL for home equity loan, HELOC for home equity line of credit, and cash-out refinance – help you reach that goal. Each option is not a one-size-fits-all method as it conjures scenarios that could suit your circumstances or not. Find out which equity-tapping option matches your liquidity needs at the moment.
HEL vs HELOC vs Cash-out Refinance
A home equity loan is a second mortgage with a fixed interest rate. The interest you pay on this second mortgage is tax deductible. Expect to pay HEL payments on top of your first-lien mortgage.
Another second mortgage, a home equity line of credit is an adjustable-rate mortgage. During its draw period (borrowing term), you can make interest-only payments. Once this period is over and transitions to repayment period, the monthly payments will increase because they will now cover both the interest and principal of the loan, plus there’s the variability of the rate.
Cash-out refinance allows you to pay off your existing mortgage balance and take home what’s left of the new loan proceeds. The new mortgage interest rate can be fixed or adjustable and tax-deductible, too. But unlike standard refinances, cash-out refis come with higher interest rates.
Which Option Is for You?
After brushing up on the three options, it’s time to nitpick on what each option has to offer and which option overall is most financially prudent.
- If you’re looking to receive a lump sum amount, you can opt between a HEL and a cash-out refinance. You’ll receive the money at closing and free to spend however you want.
- If you’re looking to access cash over a period of time, opt for a HELOC. It’s like a credit card: you can borrow up to a credit limit and can make minimum payments (interest-only payments) on what you borrowed during the draw period.
- If you’re afraid of rate disruptions and thus looking for a fixed-rate loan product, a cash-out loan or HEL would be an option. Although if you are savvy enough to understand ARMs, a HELOC is available.
- If you’re looking to pay less closing costs, there are some lenders who charge minimal to no closing costs on second mortgages. Cash-out refinances require the same closing costs as when you took out your original mortgage although some lenders can allow them to be included in the loan.
- If you’re home-equity rich, you can take advantage of a cash-out refinance to get cash and at the same time, lower your rate, convert your variable-rate loan to a fixed-rate one, shorten your term, etc.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.