Choosing between a home equity line of credit (HELOC) and a cash-out refinance is a high-stakes decision that can cost (or save) you thousands of dollars in the long run. Because both options use your home as collateral, the right choice protects your equity, while the wrong one can significantly increase your financial risk.
From real-life math scenarios to detailed comparisons, this guide gives you the clarity you need to choose with confidence.
Start here: A 60-second decision guide
Choosing between a HELOC and a cash-out refinance is not a question of “which one is better.” It all depends on your financial situation and prevailing market conditions.
- If you have a record-low mortgage rate (e.g., <3.5%): A HELOC is usually the better option because it allows you to access cash without losing your existing low interest rate.
- If your current mortgage rate is significantly higher than today’s market rate: A cash-out refinance will allow you to lower the interest on your entire debt while receiving the difference in cash.
- If you prefer stability of fixed payments: Unlike a HELOC, a cash-out refinance typically comes with a fixed rate, which locks in a set payment for the life of the loan.
- If you’re unsure how much money you need: A HELOC lets you borrow only what you need, when you need it, and you don’t pay interest on the rest.
Eligibility and terms vary significantly depending on the lender and your credit profile.
The 3 options in 1 minute
HELOC: Open a credit line secured by the property, allowing you to borrow against your home’s equity as needed during the draw period.
- Remember: While initial payments are usually interest-only, the later shift to include principal repayment may cause significant payment shock for some borrowers.
Cash-out refinance: Replace your existing mortgage with a new, larger loan and receive the difference in cash at closing.
- Remember: This resets your loan terms completely, creating a new mortgage with a current interest rate.
Home equity loan: Borrow against your home’s equity to receive a lump sum with a set interest rate and fixed monthly payments.
- Remember: Taking out a home equity loan does not replace your first mortgage and will result in two separate monthly payments.
HELOC basics: How it works and what to know
Think of a HELOC as a credit card with much higher stakes: Your property acts as collateral. This type of loan typically has two stages, the draw period and the repayment period.
During the draw period (the first 5-10 years), you can borrow up to your limit. If you repay the balance, you can withdraw it again, often paying only the interest on the amount borrowed.
Once the repayment period kicks in, you can no longer draw money; instead, you must begin paying back both principal and interest over a set term.
HELOCs almost always have variable interest rates tied to the prime rate. This means your minimum payments can change significantly based on market fluctuations.
The fine print (simplified)
A HELOC’s variable rates can make it difficult to budget for monthly payments long-term. Also, if your financial situation worsens or your home’s value drops, the lender may reduce or freeze your line of credit.
Cash-out refinance basics: How it works and what to know
A cash-out refinance works differently. Instead of adding a second mortgage on top of your first one (which is the case with a HELOC), it replaces your existing mortgage entirely. You take out a new, larger mortgage, converting a portion of the existing home equity into cash.
A significant expense in taking out a cash-out refi is closing costs, which typically range from 3% to 6% of the loan amount.[1] Many lenders will allow you to roll these costs into the new loan, so you wouldn’t have to pay anything upfront, but you’d have to pay interest on these costs over the duration of your loan.
To see exactly what you’ll pay, refer to your Loan Estimate.[2] It is the best tool for comparing costs, the Cash to Close amount, and even what your loan balance would look like five years from today.
The big tradeoff
Losing your current interest rate is one of the biggest factors when considering a cash-out refi. For example, if you secured a mortgage at 3.15% a few years ago, a cash-out refinance will reset your terms and could raise the interest to more than 6%.
HELOC vs cash-out refinance: Making a decision
To decide whether a HELOC or cash-out refinance is a better fit for you, here are the main factors to consider.
The payout method
A cash-out refinance gives you a one-time lump sum, ideal for single, predictable expenses, like credit card consolidation. Conversely, a HELOC can act more as a safety net for projects that have no set cost, such as multi-stage renovations.
Paul Rowan, the owner of The Key to The Finger Lakes, notes that the power of HELOC lies in its flexibility: “If you are able to pay down the balance on your HELOC, you will have no interest due on that portion of the line of credit.
“It gives you the opportunity to periodically pay down the balance, but then borrow it again as needed, which can be a great way to manage your cash flow,” he adds.
Rates and monthly payments
While a HELOC usually comes with a variable rate, a refinance allows you to choose between fixed and variable rates (with fixed being the standard choice). Your HELOC monthly payments will likely increase after the draw period, while a fixed-rate refinance payment remains unchanged throughout the loan’s life.
Finally, consider the logistics: A refi replaces your current mortgage, keeping you at a single monthly house payment. A HELOC, however, is a second mortgage that sits on top of your original one, resulting in two separate monthly payments to manage.
Upfront costs
Generally, a cash-out refinance comes with higher closing costs, typically ranging from 3% to 6% of the loan amount.
With a HELOC, it’s common for lenders to offer options with low or even no closing costs at all. Furthermore, because a HELOC is a smaller line of credit rather than a full mortgage replacement, it results in lower total upfront fees.
Current mortgage rate
Most experts agree that cash-out refinancing makes sense only if your new interest rate isn’t significantly higher than your old one. If you have a record-low rate, a HELOC allows you to access equity without interfering with it.
Two example scenarios
Let’s compare two real-life situations when it may be wiser to choose one over the other.
Scenario A: You have a 3% mortgage and want to withdraw $50,000
* Let’s assume current mortgage rates are at 6%.
- If you go with a cash-out refi: You will now pay 6% on your entire mortgage and lose the 3% rate. For example, for a $500,000 home, your new monthly payment is ~$2,998 (30-year mortgage). Plus, you will need to either pay or add to your loan balance $20,000 in closing costs (4% of the loan).
- If you choose a HELOC: You keep your mortgage at 3% and only pay 6% on what you borrowed. If you still owe $500,000 on your mortgage, your monthly payment is ~$2,108, adding a HELOC interest-only payment of $250. This makes your total payments ~$2,358.
A HELOC here is the clear winner. You save money every month and avoid heavy closing costs.
Still, stay mindful of the “variable” factor that comes with a HELOC. If your budget is tight, a sudden rate hike could put your home at risk.
Scenario B: Your current rate is high and you want one payment
A cash-out refinance shines when your original loan terms are no longer competitive. For example, if you secured your mortgage at 7.5% and market rates have since dropped to 5.5%, a refinance allows you to lower your overall interest and receive the cash you need.
- Current situation: You have a $400,000 mortgage at 7.5% with a monthly payment of $2,797.
- The refi: You take out a new $450,000 loan at 5.5% to get $50,000 in cash.
Now you’re paying $2,555 a month. Your monthly payment drops by more than $200, and you walk away with $50,000. Even with the closing costs of 3-6% for a loan of this size ($13,500-$27,000), the monthly savings will allow you to break even in a few years.
Credit score and ‘bad credit’ reality check
Final terms and rates for both HELOC and cash-out refinance depend significantly on your credit profile. Generally, a lower credit score results in higher interest rates and fewer loan options.
If you plan to take out some of your home’s equity but want to secure more favorable terms:
- Correct report errors: Request a free copy of your credit report and review it for any inaccuracies that could lower your score.
- Reduce credit utilization: Pay down as much as possible on open accounts to lower your debt-to-income (DTI) ratio.
- Avoid new credit: Don’t open new credit cards or take out loans immediately before or during your application process.
While there are some industry benchmarks, every lender has specific internal rules. Speak with multiple lenders to understand their requirements and terms for your situation.
How to choose (a checklist to use today)
Here are some pointers on choosing the right lender and product for your situation:
- Estimate your home’s value and mortgage balance. Calculate how much equity you own and how much you can withdraw; most lenders want you to leave at least a 20% equity cushion.
- Check the current interest rate vs. the one you have: Is it worth it to refinance?
- Decide whether you prefer to receive a lump sum for a specific expense or a more flexible line of credit.
- Talk to multiple lenders and get several quotes per product.
- Compare Loan Estimate line items like closing costs and Cash to Close (found on page 1).
- If you’re leaning toward a HELOC, stress-test your ability to pay it if the variable rate climbs by a few percentage points.
- Make a final decision based on total cost, risk, and your timeline.
The bottom line
Choosing between the two comes down to a few questions: do you want the flexibility of the revolving line or the predictability of a fixed rate? Do you want to replace your interest rate with a better one, or prefer to keep an existing low rate at all costs?
Whatever you decide, don’t settle for the first quote. Shop around, consult a few lenders, and request Loan Estimates to see which loan would be the most cost-effective option for the long haul.
Our team at Best Interest Financial will help you figure out if a HELOC or cash-out refinance would work best for your situation. We'll look at your complete financial picture, explain your options, and find the best financing strategy for you today.
Whether you need a home equity loan, a HELOC, a cash-out refinance, or something else entirely, we'll work through the numbers with you and make sure you're confident in your decision every step of the way. Get started with a free quote from Best Interest Financial today.
FAQ
What does Dave Ramsey say about HELOCs?
Dave Ramsey strongly advises against using HELOCs, primarily because your property is tied as collateral. However, other financial experts argue that a HELOC could be a valuable tool for growing your wealth if used correctly.
How is a $50,000 home equity loan different from a $50,000 HELOC?
With a home equity loan, you receive $50,000 in a lump sum and start paying it back immediately. In contrast, a $50,000 HELOC is a line of credit to use as needed, up to a $50,000 limit.
What is the monthly payment on a $100,000 HELOC?
The payment depends on your credit score, your lender, and the current prime rate. Generally, at a 6% interest rate, a monthly interest-only payment on $100,000 would be $500. This would jump to a $716 monthly payment on a 20-year HELOC once the repayment period kicks in.
What are the disadvantages of a cash-out refinance?
The biggest drawbacks include high closing costs (typically 3-6% of the loan amount), a reduction in your home equity when you take it out, and the risk of higher monthly payments if you refinance to a higher interest rate.
Can you get a cash-out refinance with bad credit?
While approval depends on your specific situation, there are options for borrowers with less-than-perfect scores. For example, look into FannieMae HomeReady or FHA cash-out refinance programs.
HELOC vs personal loan: which is safer?
Technically, a personal loan is considered the safer option. While a HELOC offers borrowers significantly lower interest rates, it uses your property as collateral. If you’re unable to keep up with the monthly payments, you could face foreclosure.