Cash-Out Refinance vs. Home Equity Line of Credit


If you are a homeowner, your property probably has untapped value that you can turn into cash. Most people who purchase a home have home equity since the value of the property is likely more than the outstanding mortgage. Home equity represents potential cash that you can use in a variety of ways, whether it is for remodeling or to pay off other debt such as credit cards or student loans. However, if you want to tap into your home equity, what’s the best way to do it?

Most Americans strive to become homeowners, not only because home ownership gives them property that they can call home but also because real estate tends to appreciate in value. Zillow estimates that the average home normally appreciates 3-5% annually, but the Washington state real estate market has been particularly hot, with appreciation rates that are double the national average. This means property is appreciating faster than the interest rate on most savings accounts.

As property value increases, so does your home equity. When you first purchased your home, you probably made an initial down payment of up to 20% of the purchase price. That 20% represents the equity in your home at the time of purchase. As property value increases, so does the equity in your home; therefore, the longer you have the home, the more equity you accumulate.

If you want to convert that home equity to cash, there are two basic ways you can do so: Refinance your mortgage or take out a home equity line of credit (HELOC). The right choice will depend on your financial situation.

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Refinancing Your Mortgage

If you refinance, you may choose to do so at a lower interest rate in order to save money over the life of the loan, or you can choose a cash-out loan to convert home equity into cash.

There are situations where you may want to refinance in order to get a better rate or better loan terms. For example, if you have an interest-only loan, refinancing could normalize the terms to give you a set monthly payment. When you refinance for a better rate, there will be closing costs, probably 1-1.5% of the loan, but that’s calculated into the mortgage payments—so you never actually receive any money.

With a cash-out loan, you are refinancing your home using its higher appraised value. You basically are taking out a larger mortgage and converting the difference between what you owe and the new value of the home into cash. When you complete the cash-out, you will have a larger mortgage and higher monthly payments, but you also will have the additional money available for other purposes.

Taking a Home Equity Line of Credit

A HELOC uses the same home equity but is structured differently from a mortgage. Instead of taking the equity from the property in one lump sum, you are using it as collateral for a line of credit. Most lenders will issue a line of credit of up to 80-90% of the total amount of home equity.

A HELOC works somewhat like a credit card in that it offers revolving credit. Once the line of credit is issued, you can draw from it. Many lenders also have a minimum draw that you will have to take out even if it is more than you need.

There are some drawbacks to a HELOC. In most cases, the interest rate is adjustable, which means your interest rate could increase with the market. Most HELOCs also have a limited draw period of 5-20 years but a repayment period of 10-20 years; during the draw period, the payments often are interest-only, but payment amounts increase after the draw period. Also bear in mind that you are using your home as collateral, so if you can’t make the payments, you could lose it.

Choosing How to Refinance

There are many reasons you may want to tap into your home equity, and depending on your financial strategy, either refinancing your mortgage or applying for a HELOC could work for you.

For example, if you need to pay off debt or make a one-time purchase, refinancing your mortgage could give you the cash you need. If you have long-term plans, such as an ongoing remodeling project, then a HELOC could give you more flexibility.

Whatever your plans, we can help. iQ Credit Union has experts who specialize in mortgages, home loans, and helping homebuyers. Consult with your bank or credit union and get the most from your home equity.


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