HELOC vs. Home Equity Loan vs. Cash-Out Refinance: Which Is Best?

Many Northern Virginia owners have built a lot of equity, and it’s tempting to use it for a renovation, college costs or a down payment on a second property. The right tool depends on how much you need, when you need it and the rate on your current mortgage.

Side by side

	HELOC	Home equity loan	Cash-out refinance
How you get money	Draw as needed	Lump sum	Lump sum
Rate	Usually variable	Fixed	Fixed or adjustable
Affects first mortgage?	No	No	Yes, replaces it
Closing costs	Often low	Low to moderate	Similar to a new mortgage
Best for	Projects paid in stages	One known cost	When the new rate beats your current one

An example with real numbers

Say your home is worth $800,000 and you owe $380,000 at 3.25% with 25 years left. Your principal and interest is about $1,852. You want $100,000 for a kitchen and basement project.

• Cash-out refinance: a new $480,000 loan at an example rate of 7% costs about $3,193 a month, or $1,341 more than today, because you give up your 3.25% rate on the whole balance.
• Home equity loan: $100,000 at an example 8% fixed over 15 years costs about $956 a month, and your first mortgage stays at 3.25%.
• HELOC: at an example 8.5% variable rate, an interest-only payment on the full $100,000 is about $708 a month during the draw period. If you only draw $40,000 at first, you pay interest only on that.

In this case, keeping the low first mortgage and using a second lien is the clear winner.

Which one I’d look at first

Your situation	Usually start with
Low first mortgage rate, one big project	Home equity loan
Low first mortgage rate, work done in phases	HELOC
First mortgage rate higher than today’s rates	Cash-out refinance
Short-term need, such as buying before you sell	HELOC, if you can repay it soon

Owners who bought or refinanced when rates were very low usually want to protect that first mortgage. A second lien lets you borrow what you need without touching it.

How much can you borrow?

Lenders look at your combined loan-to-value. At an 85% limit, an $800,000 home supports $680,000 of total debt. Subtract the $380,000 first mortgage, and up to $300,000 could be available, subject to credit and income.

Lenders also look at your credit score, income and debt-to-income ratio, just as they would for a first mortgage. If you’re planning a project, get contractor bids first so you borrow the right amount. Borrowing far more than you need on a HELOC isn’t costly by itself, but it can tempt you to spend it.

Tax rules

Under current federal law, interest on home equity debt is deductible only if you use the money to buy, build or substantially improve the home that secures it, and only within the overall $750,000 limit. Paying off a car or credit cards doesn’t qualify. I’m not a tax advisor, so confirm with your CPA.

Common mistakes

• Ignoring the variable rate. A HELOC payment can rise. Stress-test it at a rate 2 points higher.
• Forgetting the repayment phase. When the draw period ends, many HELOCs switch to principal and interest, and payments jump.
• Planning to sell soon. Some HELOCs charge early closure fees. Read the terms.
• Borrowing for depreciating things. Turning home equity into vacation or car debt puts your home at risk for something that loses value.

If your project is about resale, read Renovations That Add the Most Value. If you’re thinking about refinancing instead, see When to Refinance.

Frequently asked questions

Does a HELOC affect my credit?

Yes. It’s a new account, and using a large share of the line can affect your score.

Can I get a HELOC on a rental property?

Some lenders offer them, usually at higher rates and lower limits.

How long does it take?

Often two to six weeks, depending on the appraisal and the lender.