HELOC vs. Cash-Out Refinance

Disclaimer: Billdr is not a financial institution and therefore cannot offer any financial advice. This article is intended for informational purposes only. Please speak with your financial advisor to receive further information to make an informed decision about your finances.

You’ve decided to go forward with your home renovation, and are now looking into ways in which you can easily fund your project, but there is a list of options to choose from. In this guide, we will cover two different loan options: HELOC and cash-out refinancing. Both are ways to receive money by tapping into the equity of your home.

But what is the difference between the two options and how do you choose? Here, we will outline what these loan options are, how they differ, and the pros and cons of each so you get on track to making an informed decision for your home renovation.

What is a HELOC?

A HELOC, or a home equity line of credit, is a type of loan that allows homeowners to withdraw funds from the equity of their home as they need it over a set period of time. Similar to a credit card, you can withdraw funds up to a certain limit from your HELOC during the draw period, which is typically 10 years. During the draw period, you will make monthly minimum payments dependent on how much you have withdrawn that are typically interest only, but some lenders can also request principal payments as well. 

You will eventually pay back the outstanding balance of the loan that includes both principal and interest during the repayment period, which is typically 20 years. People can use HELOCs for any kind of expense, such as a home renovation or extension, or even debt consolidation. HELOCs can sometimes offer lower interest rates compared to other types of loans, but this can vary depending on your lender.

Here are some pros and cons of HELOC that will help you determine if this loan option is right for you:

  • Interest only payments: Typically, HELOCs allow homeowners to have interest-only payments. This means that during the draw period, homeowners are usually only charged with interest fees and will not have to pay for principal fees until the repayment period. This can vary based on financial situation and lender.
  • Only take what you need: A homeowner can decide exactly how much they would like to withdraw from their HELOC and only have to worry about paying back the amount they took out, plus interest. Whether it be for a kitchen remodel or a home extension, the amount of money that is withdrawn from this loan is entirely up to the homeowner, making it a flexible loan option.
  • Interest rates can vary: HELOCs typically come with variable interest rates, which means that the interest rate you pay is dependent on the current economy. The interest rate that is in place at the time of taking out a HELOC can be different from the interest rate during your payment period. Depending on your lender, a fixed-rate loan option can potentially offer some stability with interest payments. To learn more about a fixed-rate loan, check here if you are a resident of the US, and here if you are a resident of Canada.
  • Set draw period: Typically, HELOCs use a 30-year model, with a 10-year draw period and a 20-year payback period. Since a HELOC is only offered as a line of credit during that draw period, you will no longer be able to access the funds from that loan when the 10-year period is up.

What is cash-out refinancing?

Cash-out refinancing also means accessing the equity of your home, but this loan option replaces your current mortgage with a larger one and you receive the difference of those loans in cash. As opposed to a HELOC where you can withdraw funds from that loan over a period of time as you need it, cash-out refinancing delivers the loan in a one-time, lump sum payment. This requires that the new mortgage be paid back entirely during the repayment period, regardless of how much you need to use at that moment. 

For example, a loan of $100k in the form of a HELOC can be used entirely at the homeowner’s discretion as they will only have to pay back interest and principal fees for funds that they used, making this loan type very similar to a credit card. With a cash-out refinance loan, that $100k will be delivered to the homeowner all at once and has to be repaid in its entirety during the repayment period.

A cash-out refinance can offer fixed interest rates and longer repayment periods, which might be helpful to homeowners looking for a type of loan with more stability. 

Check out some pros and cons of a cash-out refinance that will help you determine if this loan option is right for you:

  • Fixed interest rates: Cash-out refinances typically have fixed interest rates which means that you will have consistent monthly payments. With a fixed rate, you can confidently pay back your loan as the monthly fees are consistent.
  • Take your time with repayment: These types of loans come from establishing an entirely new mortgage, so you will typically have a longer period of time to repay it. This means more affordable monthly payments and less stress.
  • Additional fees: Similar to any other form of refinance, cash-out refinances usually include closing costs, which means more money upfront. These can require you to pay for fees such as appraisal and title fees that can add a measurable amount on top of your loan. 
  • Once you have it, it’s yours: Unlike a HELOC that allows you to withdraw funds from the loan as you need it, a cash-out refinance delivers the money to you all at once and is required to be paid back in its entirety over a period of time. Although you can also use the money from this loan as you wish, you will not have the freedom to only pay back what you used.

Make an informed decision

Taking out a loan for a home renovation project can be very useful for many homeowners who are looking for a way to access extra funds, but ultimately is also an important decision that should be well thought out. To get more information about HELOC and cash-out refinance loan options, we advise you to speak to your lender to learn more about each loan so you can determine which one is best for you.

Finance your project with nesto

Are you a resident of Canada who is looking for a way to fund your next home renovation project? Check out nesto, a mortgage lender that offers some of the lowest refinance rates. nesto offers a streamlined financial service that can help you get the best rate on your mortgage with little to no stress.