If you own your home, you've probably built up some equity over the years. You might be considering how to use it for home improvements, consolidate debt or covering any large expenses that may come up.

If you’re tapping into your equity this is where deciding between a cash-out refinance² and a Home Equity Line of Credit (HELOC)¹ comes in. The best choice depends on your financial needs and goals. Learning about HELOCs and cash-out refinancing can help you determine which option works best for you.

Have you already made your decision? Check out Rate's HELOC or cash-out refinance options, and start an application.

What is a HELOC and how does it work?

A Home Equity Line of Credit (HELOC) offers a flexible credit line that allows you to access your home’s equity. It works much like a credit card, enabling you to borrow money repeatedly within a set limit.

Unlike traditional loans that offer a lump-sum, a HELOC gives you a line of credit during what is called the draw period, which typically lasts five to 10 years. During this time, you will make interest-only payments on the amounts you withdraw.

During the repayment period that follows, which can last 10 to 20 years, you’ll repay both the principal and the interest. This option is particularly helpful for covering expenses where you are unsure what the final costs will be, like home improvements or unexpected costs.

However, keep in mind that during the repayment period, your monthly payments could increase significantly, so planning ahead is essential.

HELOC benefits and risks

Benefits

A HELOC offers unique home loan advantages that can make it a smart choice for many homeowners:

Debt consolidation: HELOCs can help you manage high-interest debt, like credit cards or personal loans, by consolidating it into one payment that may have a lower interest rate overall.

Investment opportunities: If you’re funding an investment, like buying a rental property or a small business, a HELOC provides flexible funds you can use strategically as opportunities arise.

Tax advantages: HELOC interest may be tax-deductible depending on how you use your funds. Home improvement projects could qualify you for tax advantages and also increase your home’s value.³

Emergency access to funds: A HELOC serves as a financial safety net for unplanned expenses, like medical bills or urgent home repairs. The ability to draw funds when needed means you’re not paying interest on money you don’t use.

Risks

While HELOCs are flexible and come with many benefits, there are risks to keep in mind before borrowing.

Rising interest rates: Most HELOCs come with variable interest rates, meaning your monthly payments can go up if interest rates rise.

How to protect yourself: Consider a loan that lets you lock in a fixed rate. This can provide more predictable monthly mortgage payments and peace of mind.

Borrowing too much: Since HELOCs give you ongoing access to funds, it’s simple to overspend or borrow for things that don’t add value, like vacations or luxury items. You may end up with too much debt and risk foreclosure.

How to stay on track: Stick to a clear financial plan and borrow only what you need (and can comfortably repay).

Impact on home equity: Every time you borrow from your HELOC, you reduce the amount of equity in your home. If your home value declines, this could leave you with less financial flexibility.

How to mitigate this: Be mindful of how much you’re borrowing and avoid using your HELOC for expenses that won’t provide a long-term benefit to your financial situation.

Types of HELOCs Available

HELOC loans come in two mortgage types: fixed rate and variable rate. With a variable-rate HELOC, your interest rate is often tied to current interest rates and can change over time. This means that your payments are subject to change.

A fixed-rate HELOC, on the other hand, gives you security with steady monthly payments, but you may not be able to change the terms as easily.

Which one you choose depends on how comfortable you are with changes to your payments. While a variable rate could potentially save you money, it may not be the best option if you prefer having a more structured approach.

HELOC Requirements

For a HELOC, lenders usually look at a few key factors:

• Credit Score: Most lenders want applicants to have a credit score of at least 680, but some consider borrowers with scores as low as 620.
• Debt-to-income (DTI) ratio: Lenders usually want a DTI ratio of 50% or less, which means that your monthly debt payments should not be more than 50% of your gross monthly income.
• Home equity: You should have 15% to 20% equity in your home. This means your mortgage HELOC debt shouldn’t exceed 80% to 85% of your home’s current market value. 

What is a cash-out refinance, and how does it work?

A cash-out refinance is a way to use the value of your home to your advantage by replacing your current mortgage with a bigger one and getting cash up front.

This option allows you to take the cash difference between your new loan and the remaining balance of your original mortgage for major expenses like home improvements, consolidate other debt or education.

However, it's important to know how interest rates affect this process. While securing a lower rate could save you money every month, refinancing may not be worthwhile if current rates are higher than your original mortgage rate.

If you refinance with a larger loan balance, your monthly mortgage balance might go up, even if you can get a lower rate. This means you should consider how your budget may change and how it will affect your finances long-term.

For example, if you want to extend your loan term after nearly finishing your original mortgage payment, the total interest you pay could increase.

Benefits and drawbacks of cash-out refinance

Benefits

Access to a lump-sum of cash: You can use cash-out refinancing to quickly access a large amount of money, which can be used for major expenses like home renovations, consolidating high-interest debt or covering education expenses.

Potential for lower interest rates: If market rates are lower than the rate on your existing mortgage, a cash-out refinance allows you to replace your old loan at a reduced rate. This could lead to bigger savings* over the life of the loan.

Flexible options for borrowers with low credit: Even if you have less-than-perfect credit, some lenders offer refinancing programs tailored to homeowners in your situation. While the rate might be higher, this option still unlocks the equity in your home to help meet financial goals.

Drawbacks

Higher long-term interest costs: Extending the loan term by refinancing can increase the total interest paid over the life of the loan.

To minimize long-term costs, consider getting a cash-out refinance with a shorter term, like 15 or 20 years. While your monthly payments may be higher, you’ll save money on interest.

Closing costs can add up: Refinancing typically comes with closing costs that range from 2% to 6% of the loan amount. While some lenders offer “no-closing-costs” options, these often come with higher interest rates.

How to manage this: Shop around for lenders that offer competitive refinance rates and closing costs. If you need to preserve cash up front, ask about rolling these costs into the loan.

Risk of overleveraging: Taking on a larger mortgage increases your debt and reduces your home equity. If your property value declines, you could owe more than your home is worth, making it difficult to sell or refinance later.

How to protect yourself: Borrow only what you truly need and ensure your loan-to-value (LTV) ratio stays within manageable limits. Aim for an LTV of 80% or less to leave a financial cushion.

No closing fee refinance options

Some lenders let you refinance with no closing costs, which means they pay for the costs up front. This may sound good, but keep in mind that the interest rate is usually a little higher.

This choice can help you keep your cash in hand while lowering your out-of-pocket costs.

Low Credit Refinance Options

There are refinancing programs specifically for borrowers with lower credit scores.

Cash-out refinancing could still be a beneficial way to get access to your home's wealth, even if you have bad credit and the interest rate is higher.

You might find favorable terms by shopping around.

Refinance Requirements

To qualify for a cash-out refinance, you need to meet certain financial criteria that demonstrate your ability to manage the new loan responsibly. These requirements include:

Credit score: Most conventional loans need a credit score of at least 620, but some programs may accept credit scores lower than that.

Home equity: Your loan-to-value (LTV) number shouldn't be more than 80%, which means you should have at least 20% equity in your home.

Debt-to-Income (DTI) ratio: Lenders like a DTI ratio of 43% or less, which means that your monthly debt payments should not be more than 43% of your gross monthly income.

Choosing Between a HELOC and cash-out refinance

When thinking about whether to get a HELOC or a cash-out refinance, consider your monthly income, current mortgage interest rates and financial goals to figure out which choice fits your real estate needs the best.

Rate offers both options, and we can also help you in making choices that fit your budget and lifestyle. Apply for Rate's HELOC or cash-out refinance to help you get the most out of your home and start accessing your equity today!

*Savings, if any, vary based on the consumer’s credit profile, interest rate availability, and other factors. Contact Rate for current rates. Restrictions apply.

¹ Rate home equity line of credit (HELOC) is an open-end product where the full loan amount (minus the origination fee) will be 100% drawn at the time of origination. The initial amount funded at origination will be based on a fixed rate; however, this product contains an additional draw feature. As the borrower repays the balance on the line, the borrower may make additional draws during the draw period. If the borrower elects to make an additional draw, the interest rate for that draw will be set as of the date of the draw and will be based on an Index, which is the Prime Rate published in the Wall Street Journal for the calendar month preceding the date of the additional draw, plus a fixed margin. Accordingly, the fixed rate for any additional draw may be higher than the fixed rate for the initial draw. This product is currently not offered in the states of New York, Kentucky, West Virginia, Delaware and Maryland. The HELOC requires you to pledge your home as collateral, and you could lose your home if you fail to repay. Property insurance is required as a condition of the loan and flood insurance may be required if your property is located in a flood zone. Borrowers must meet minimum lender requirements in order to be eligible for financing. Available for primary, second homes and investment properties only. Dependent on minimum credit score and debt-to-income requirements. Occupancy status, lien position and credit score are all factors to determine your rate and max available loan amount. Not all applicants will be approved. Applicants subject to credit and underwriting approval. Contact Rate for more information and to discuss your individual circumstances. Restrictions Apply.

² Using funds from a Cash-out Refinance to consolidate debt may result in the debt taking longer to pay off as it will be combined with borrower’s mortgage principle amount and will be paid off over the full loan term. Contact Rate for more information

³ Rate does not provide tax advice. The consumer should always consult a tax advisor for information regarding the deductibility of interest and other charges in their particular situation.