Quick overview
A Home Equity Line of Credit (HELOC) is a revolving credit line secured by your home’s equity; you draw, repay, and redraw during a draw period. A cash-out refinance replaces your current mortgage with a larger loan, paying off the old loan and giving you the difference in cash at closing. Both use your home as collateral, so missed payments can lead to foreclosure. This guide compares costs, timing, eligibility, tax considerations, and real-world scenarios to help you choose the right route.
How HELOCs work (practical details)
- Structure: HELOCs are open-ended credit lines with a maximum limit based on your combined loan-to-value (CLTV) ratio. During the draw period (often 5–10 years) you can borrow up to the limit and typically make interest-only or interest-plus-principal payments. After the draw period, the loan enters repayment and payments increase.
- Interest: Most HELOCs have variable interest rates tied to an index (e.g., prime rate) plus a margin. Some lenders offer a conversion option to lock a portion into a fixed rate.
- Costs: Closing costs vary — some lenders waive them or charge small origination fees, but appraisal, title, and recording fees are common. Annual fees or inactivity fees may apply.
- Typical uses: Staged home renovations, short-term liquidity, or ongoing expenses where you won’t need a lump sum upfront.
For more on HELOC terms and options, see our guide on Home Equity Line of Credit (HELOC).
Internal link: HELOCs vs Home Equity Loans: When to Use Which for Renovations — https://finhelp.io/glossary/helocs-vs-home-equity-loans-when-to-use-which-for-renovations/
How cash-out refinances work (practical details)
- Structure: A cash-out refinance pays off your existing mortgage and replaces it with a new loan for a higher principal amount. You receive the difference in cash at closing.
- Interest & term: You can choose a fixed- or adjustable-rate mortgage; the new rate and term may be longer or shorter than your previous mortgage, which affects monthly payments and total interest paid.
- Costs: Cash-out refinances have closing costs similar to initial mortgages (appraisal, title, origination, lender fees). These can be financed into the loan but will increase your balance.
- Typical uses: Large one-time expenses—major renovations, consolidation of high-interest debt, or funding an investment where a single lump sum is preferable.
Key differences at a glance
- Disbursement: HELOC = draws over time; Cash-out refinance = lump sum at closing.
- Payment predictability: HELOC = often variable during draw/replay; Cash-out = can be fixed monthly payment if you choose a fixed-rate mortgage.
- Costs: HELOCs often have lower upfront costs but can carry ongoing fees. Cash-out refinancing usually has higher closing costs but can lower interest rate risk with a fixed mortgage.
- Impact on loan term: HELOCs typically do not reset your primary mortgage term. Cash-out refinancing usually restarts amortization under the new loan terms and can lengthen your amortization.
- Effect on LTV/PMI: Cash-out increases your primary mortgage balance and may push LTV above thresholds that trigger private mortgage insurance (PMI). HELOCs count toward CLTV for future lending decisions.
For a deeper dive on how CLTV affects refinance eligibility, see: Combined LTV (CLTV) and Its Effect on Refinance Eligibility — https://finhelp.io/glossary/combined-ltv-cltv-and-its-effect-on-refinance-eligibility/
Eligibility and underwriting
Lenders look at these core criteria for both products:
- Equity: Most lenders want you to retain some equity after borrowing. Typical maximum combined LTVs vary by product and lender. For owner-occupied homes, many HELOCs and cash-outs cap CLTV between 80%–90% depending on income and credit.
- Credit score and history: Better rates and terms go to borrowers with stronger credit. Many HELOCs accept scores 620+, but the best pricing requires higher scores.
- Debt-to-income (DTI): Lenders commonly prefer DTI below ~43%, though acceptable thresholds can differ by lender and loan program.
- Income documentation: Pay stubs, tax returns, and asset statements are usually required.
Tip from practice: lenders treat cash-out refinances as a mortgage underwriter would — expect full documentation and sometimes stricter seasoning requirements (time since purchase) than for a HELOC.
Costs to compare (what to calculate)
When deciding, run the math on:
- Closing costs and prepaids (appraisal, title, escrow, origination).
- Ongoing fees (annual HELOC fees, inactivity fees, margin adjustments).
- Interest rate differences and whether the HELOC has rate caps.
- Total interest paid across the life of the loan(s).
- How the loan affects your monthly cash flow and overall mortgage timeline.
Example calculation approach: compare the net cash you’d receive after closing costs, then model monthly payments under each scenario (including a future rate stress test for variable HELOC rates).
Tax considerations (brief, up-to-date guidance)
Mortgage interest is not automatically deductible on all loans. Interest on home equity borrowing may be deductible only if the loan proceeds are used to buy, build, or substantially improve the home securing the loan, subject to IRS rules and limits. Tax rules changed after 2017 and have limits on acquisition indebtedness and home equity interest deductibility; consult IRS guidance or a tax professional for your situation (see IRS guidance on mortgage interest).
Authoritative resource: Consumer Financial Protection Bureau on home equity lines of credit — https://www.consumerfinance.gov/
IRS overview on mortgage interest deduction — https://www.irs.gov/
Risks and common pitfalls
- Secured by your home: Both products use your house as collateral—missed payments could lead to foreclosure.
- Variable-rate risk: HELOCs often have variable rates, which can increase payments sharply in a rising-rate environment.
- Payment shock: After a HELOC draw period ends, payments can jump when principal repayment begins.
- Rolling closing costs into the loan: Financing costs into your mortgage increases your loan balance and interest expense over time.
- Misusing the funds: Using home-equity credit for nonproductive purposes (e.g., discretionary spending) can magnify risk if home values fall.
Practical decision checklist (step-by-step)
- Define the purpose: One-time large expense (favor cash-out) vs. ongoing staged costs (favor HELOC).
- Get a home-value estimate and calculate current LTV and CLTV if you have other liens.
- Shop rates and fees for both a HELOC and a cash-out refinance; request loan estimates from lenders.
- Run scenario models: monthly payment, total interest paid, and a 2–3% rate increase stress test for HELOCs.
- Check tax implications with a CPA or tax pro if deductibility matters.
- Factor timing: cash-out refinancing can take longer to close than a HELOC, depending on lender.
- Read loan documents carefully for draw-period end terms, prepayment penalties, and conversion options.
Real-world examples (brief)
- Renovation staged over 3 years: homeowner chose a HELOC for the flexibility to draw as each project started and to avoid refinancing their primary mortgage.
- Debt consolidation of high-interest credit cards: borrower did a cash-out refinance to secure a lower fixed rate and use a lump sum to pay off credit cards—this lowered monthly payments but extended mortgage amortization.
When each option commonly makes sense
- Choose a HELOC if you: need flexible access over time; expect to repay draws within a relatively short horizon; are comfortable with variable rates or can convert portions to fixed rates.
- Choose a cash-out refinance if you: need a single large lump sum; prefer a stable fixed rate; want to consolidate debt into one fixed monthly payment; or can obtain a lower overall rate than your existing mortgage.
Next steps and resources
- Get a current appraisal or broker pricing opinion to know your equity.
- Request loan estimates from at least two lenders for each product.
- Talk to a tax professional about interest deductibility for your intended use of funds.
Internal resources from FinHelp to read next:
- HELOCs vs Home Equity Loans: When to Use Which for Renovations — https://finhelp.io/glossary/helocs-vs-home-equity-loans-when-to-use-which-for-renovations/
- Combined LTV (CLTV) and Its Effect on Refinance Eligibility — https://finhelp.io/glossary/combined-ltv-cltv-and-its-effect-on-refinance-eligibility/
Professional disclaimer
This article is educational and reflects common practice and industry rules as of 2025. It is not individualized financial, legal, or tax advice. Consult a qualified mortgage professional, CPA, or attorney before taking action.
Sources and recommended reading
- Consumer Financial Protection Bureau, Home Equity Lines of Credit (HELOCs) — https://www.consumerfinance.gov/
- Internal Revenue Service, Topic: Home Mortgage Interest — https://www.irs.gov/
- FinHelp glossary pages listed above for product-specific details.
