Homeowners who need cash can often tap into their home equity to get it. That means borrowing against the ownership you have in your home to access cash at a low interest rate.

Financial institutions offer a number of ways to borrow against home equity, and the right method depends on your situation. Typically, homeowners seek home equity loans or lines of credit (HELOC) to access their equity, but a cash-out refinance can accomplish a similar result.

How Does a HELOC Work?

A HELOC is a line of credit guaranteed by the equity you have in your home. Most lenders allow qualifying homeowners to borrow up to 80% or 90% of the equity in their homes.

HELOCs are interest-only loans for a specific term, such as 10 years. Because the payments during that term are strictly interest—no principal—they will likely be lower than regular mortgage payments, which include principal and interest.

The first part of a HELOC term is the draw period. This means you’re able to withdraw whatever you need from the loan, when you need it, up to the total approved limit. Each month, you only pay interest on the amount of the loan you’ve used, so you may not be paying interest on the full amount for which you qualify. However, HELOCs typically are adjustable-rate loans based on the prime rate, which means your interest rate could potentially rise over time.

After the draw-down term ends, the repayment period begins, in which you’ll pay a combined interest-and-principal payment every month until the loan is paid off.

One other thing to consider: Because mortgage interest rates are historically low, HELOCs may be difficult to come by. “Some banks are not even taking applications for HELOCs because they have so much demand for purchasing and refinancing mortgages,” says Brian Jass, CRPC and advisor with Great Waters Financial in Minneapolis.

How Does a Home Equity Loan Work?

Similar to a HELOC, a home equity loan is secured by the equity you have in your home. But instead of allowing you to withdraw what you need when you need it, a home equity loan is paid to you in one lump sum.

Like a first mortgage, a home equity loan lets you borrow a specific amount for a set term. The amount you can borrow is usually a percentage of the equity you have in your home, such as 80%. Because you get the full amount upfront, your payments include both principal and mortgage from the outset. Some home equity loans offer a fixed rate, just like a traditional mortgage loan. You can find home equity loans with terms from five to 30 years.

How Does a Cash-out Refinance Work?

When you refinance a mortgage, you pay off your existing mortgage and open a new mortgage loan. People often refinance to get a lower mortgage rate or better terms. Many lenders allow qualifying borrowers to “cash out” some of their existing home equity in the refinance process. With the current low mortgage interest rates, a cash-out refinance could allow homeowners to access cash and get better mortgage terms at the same time.

For instance, imagine your home is worth $300,000 and you owe $200,000. If your lender offers cash out of up to 80% of the value of your home, you’d be allowed to borrow a total of $240,000. With a cash-out refinance, you could access $40,000 in cash and get a new mortgage for $240,000. While your mortgage amount would be higher, your payment could be lower or about the same, if you were able to get a lower interest rate. And you’d have $40,000 in cash for a remodel, college tuition or whatever need.

A cash-out refinance allows a borrower to take advantage of fixed, low-interest rates over the life of the mortgage loan—such as 15 years or 30 years—but those rates may not be the lowest of the low. “The interest rate is different for a straight refinance than it is for a cash-out refinance,” Jass says. “Usually, you’ll pay about a half percent higher to get that cash back.”

It’s often easier to qualify for a cash-out refinance than for a home equity loan or HELOC. That’s because the loan you get with a cash-out refi takes the place of your original mortgage loan, allowing the lender to hold your first mortgage. HELOCs and home equity loans are considered second mortgages: If you default, they will be paid back only after your first mortgage is paid

How Cash-Out Refinances, HELOCs and Home Equity Loans Compare

All three lending options let you tap into your home equity, but they have key differences.

Cash-out Refinance HELOC Home Equity Loan
Basics Refinances current mortgage and provides a cash payment based on available equity in the home
  • Line of credit based on equity in the home
  • Money can be accessed during a draw period
  • Interest-only payments may be made during the draw period, and after it ends, repayment of the principal begins
Second mortgage that’s based on available equity in the home
Term 15- and 30-year terms are most common

Draw periods are often five to 10 years; repayment periods often 10 to 20 years

Five to 30 years
Reduces equity in home? Yes

Yes

Yes
Payout Lump sum As needed during draw period Lump sum
Replaces current mortgage? Yes

No

No
Fees Closing costs range from 2% to 6% of the loan amount
  • Some institutions may waive closing costs
  • An annual fee and/or early termination fee may apply
Some institutions may waive closing costs
Typical interest rate Fixed or variable

Usually variable, but fixed-rate options exist

Fixed
Best for Those who want a single loan payment and expect to live in their home for at least five more years

Those who want the flexibility to tap into their home’s equity at any time

Those who need a specific amount of money and prefer a fixed interest rate

Which One Is the Easiest To Qualify For?

A cash-out refinance is often the easiest to qualify for since you maintain only one loan on your property. They are less risky for lenders who will be first in line to receive any proceeds should you stop making payments and lose your home to foreclosure. Many lenders will approve cash-out refinances to homeowners with credit scores as low as 620 or, for some loan programs, 580.

“A HELOC may provide a simpler application and approval process than a home equity loan or a cash-out refinance but often requires a higher credit score to obtain,” says Jackie Boies, a senior director of partner relations at Money Management International, a HUD-approved national housing counseling intermediary.

Determining Which One Is the Right Choice

If you’re choosing between a HELOC and a cash-out refinance, the right choice depends on your particular needs and timeline. Generally, it’s important to consider when you plan to use the cash—now, later or in increments—and how long you plan to stay in your home.

For instance, if you don’t need all the money at once but just want to have it available on demand, a HELOC is probably your best option. With a HELOC, you’re granted access to the agreed-upon amount of cash, but you withdraw only what you need when you need it.

For instance, you might withdraw $10,000 now to remodel your kitchen and another $10,000 next year to remodel your bathrooms. Or you may not withdraw any cash at all, simply keeping the account open in case of a layoff or furlough. Each month, you pay interest only on the amount you’ve withdrawn—or pay nothing if you haven’t withdrawn any money.

On the other hand, if you need the full amount you’re borrowing right now, a cash-out refinance or home equity loan may be ideal.

Refinancing is usually a good idea only if you plan to stay in your home for at least five years. That’s because the closing costs you’ll have to pay to refinance could cancel out the interest savings if you only have the loan for a few years. HELOCs and home equity loans, on the other hand, often don’t involve closing costs—many lenders waive or pay them for you.

The best option may also depend on the current mortgage rate environment—and the interest rate you’re paying on your current mortgage.

When mortgage rates start rising, “people will want to access capital with a HELOC rather than a refinance, because they won’t want to lose their low mortgage rate,” says Frank DiMaio, senior vice president and director of sales at Univest Bank and Trust Co.

Frequently Asked Questions (FAQs)

Do I have to pay taxes on a cash-out refinance?

No, the money you receive from a cash-out refinance isn’t taxable since the proceeds are a loan, not income.

Can I use a cash-out refinance to pay off a HELOC?

Yes, you can use the money from a cash-out refinance for any purpose, including paying off a HELOC or other debt.

Do cash-out refinances have lower credit score requirements than HELOCs or home equity loans?

Yes, since cash-out refinances are the primary mortgage on a home, lenders can be willing to grant those to homeowners with credit scores as low as 620 or even 580 in some cases. HELOCs and home equity loans are second mortgages, which come with more risk for lenders and higher credit score requirements for borrowers.

Do you lose equity when refinancing a home?

If you choose cash-out refinancing, you’ll reduce the equity in your home, and your new loan balance will be higher than your current mortgage. For that reason, while cash-out refinancing is convenient, it also comes with risks.

“A downturn in the housing market could leave you ‘underwater,’ an unfortunate situation where you owe more than your home is worth,” according to Boies.