HELOC, home equity loan or cash‑out refinance: which one fits

What is the difference between a HELOC and a home equity loan?

Both are second loans secured by your home. Both leave your first mortgage, and its rate, exactly where it is. The difference is how you receive the money and how you pay it back.

HELOC

A home equity line of credit works like a revolving line. The lender sets a credit limit, and during the draw period you borrow, repay and borrow again. When the draw period ends, you can no longer draw, and you repay the balance over a repayment period. The length of each period is set by the plan and varies by lender.

Most HELOCs have a variable rate, tied to an index such as the prime rate plus a margin. Payment terms vary by plan, and some plans let you convert part of the balance to a fixed rate. The CFPB warns that payments are often much higher once repayment starts, and some plans require a balloon payment of the full balance.

Home equity loan

A home equity loan pays you one lump sum at closing, usually at a fixed rate with a fixed payment. It fits a single, known cost, like a roof or a specific renovation.

Cash-out refinance

A cash-out refinance pays off your current mortgage and replaces it with a new, larger first mortgage. You receive the difference in cash. You end up with one loan and one payment, but on new terms.

HELOC vs home equity loan vs cash-out refinance

How much equity can I borrow against?

Every option works from the same idea: a limit on the combined total of everything you owe on the home, as a share of its value.

For a conventional cash-out refinance on a one-unit primary residence, Fannie Mae allows up to 80% of the value. Limits are lower for second homes, multi-unit homes and investment properties. For a HELOC or home equity loan, each lender sets its own combined loan-to-value limit. Many use a limit similar to 80%, and some go higher.

Fannie Mae also sets a few conventional cash-out rules worth knowing early. A first mortgage being paid off must be at least 12 months old, at least one borrower must have been on title for at least six months, with some exceptions, and a home listed for sale must come off the market first. You can also take cash out of a home you own free and clear.

Is a HELOC or a cash-out refinance better?

It mostly depends on your current rate. A HELOC keeps your first-mortgage rate. A cash-out refinance replaces it. If your current rate is well below today's rates, replacing the whole loan to borrow a smaller amount often does not make sense. If the new rate is close to or below what you have now, a cash-out refinance can be the cleaner choice.

A HELOC tends to fit when

• You have a low rate on your first mortgage you want to keep
• You need money over time, such as a renovation paid in stages
• You expect to repay the balance fairly quickly
• You can handle a payment that changes with the rate

A home equity loan tends to fit when

• You want to keep your first mortgage and know the exact amount you need
• You prefer a fixed payment over a variable one

A cash-out refinance tends to fit when

• The new rate is close to or below your current rate
• You want one loan and one fixed payment
• You are consolidating your mortgage with other debts
• You need a large lump sum, or the home is paid off

The trade-offs of a cash-out refinance are real: it resets your rate and your term, and you pay closing costs on the whole new loan, not just the cash you take. A HELOC or home equity loan adds a second payment instead.

Does a HELOC or cash-out refinance affect my first mortgage?

Cash-out refinance. Your first mortgage is paid off and gone. Any features you had, like a low rate, a shorter remaining term or an FHA or VA loan a buyer could assume, go with it.

HELOC or home equity loan. Your first mortgage stays in place and the new loan sits behind it. Two things to know:

• If you later refinance your first mortgage, the HELOC lender usually has to agree to stay in second position, called subordination, or the line has to be paid off. Whether a lender will subordinate varies by lender.
• If your first mortgage still has private mortgage insurance, cancelling it at 80% of original value requires that there are no junior liens on the home. A HELOC can get in the way of that.

The CFPB also notes that some HELOC agreements prohibit renting out the home, and that lenders can freeze or reduce a line in some circumstances. Read the agreement before you sign.

What Florida homeowners should weigh

Homestead protection

Florida's constitution protects a homestead from forced sale by most creditors. That protection does not change what you are signing here: a HELOC, home equity loan or cash-out refinance is secured by the home itself. As the CFPB puts it, if you cannot repay, you could lose your home.

Documentary stamp and intangible taxes

Florida taxes new mortgage debt. The statutory rates are 35 cents per $100 for documentary stamp tax on the note and mortgage, and 2 mills for the nonrecurring intangible tax on debt secured by Florida real estate. A second lien sized to the cash you need is taxed on that amount. A cash-out refinance creates a new, larger first mortgage, so the taxable amount can be much larger. On a line of credit that secures future advances, the statute taxes the initial debt at recording and each future advance as it is made, though how lenders handle this on a HELOC varies. Ask for these line items when you compare.

Insurance and escrow

Homeowners insurance is a major part of a Florida payment. A cash-out refinance usually sets up a new escrow account on the new loan. A HELOC leaves your existing escrow alone.

Condos

A conventional cash-out refinance on a condo requires the building to meet Fannie Mae or Freddie Mac project standards, which exclude projects that need critical repairs. With Florida's milestone inspection and reserve study laws, that review matters in many older buildings. HELOC lenders may apply their own condo rules, which vary by lender.

Is the interest tax deductible?

We do not give tax advice, and this article does not say whether your interest would be deductible. The answer depends on how you use the money, the rest of your mortgage debt and your own tax situation, and the IRS sets the rules in Publication 936. That applies equally to a HELOC, a home equity loan and the cash from a cash-out refinance. Ask your tax advisor before you count on any deduction.

How we approach it

We start with what you need the money for and when, and what your current mortgage is worth keeping. Then we compare a HELOC, a home equity loan where a lender offers one, and a cash-out refinance across our lender network, including Florida taxes and closing costs on each, so you can see the whole cost, not just the payment. If your income is easier to show with bank statements or rent, some Non-QM programs also offer cash-out, with their own limits.

Sources

• CFPB: What is a home equity line of credit (HELOC)?
• CFPB: What you should know about Home Equity Lines of Credit
• Fannie Mae Selling Guide: B2-1.3-03, Cash-Out Refinance Transactions
• Fannie Mae: Eligibility Matrix
• CFPB: Regulation Z, 12 CFR 1026.23, Right of rescission
• IRS: Publication 936, Home Mortgage Interest Deduction
• Florida Department of Revenue: Documentary Stamp Tax
• Florida Statutes: Section 201.08, Tax on promissory notes and mortgages

Common questions