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Two loans side by side

HELOC or cash-out refinance: a line behind your mortgage, or a new one in its place

A home equity line of credit (HELOC) is a line of credit secured by your home that sits behind your first mortgage, which stays as it is. A cash-out refinance is a new, larger first mortgage that pays off the old one and pays you the difference at closing. This page sets the two side by side under the public rules that govern each: Regulation Z and the Consumer Financial Protection Bureau's booklet for the line, and Fannie Mae's Selling Guide for a conforming cash-out refinance. California Mortgage Solutions, an independent mortgage broker in San Luis Obispo, wrote it for homeowners in San Luis Obispo County weighing the two; the HELOC page and the refinancing page describe each in full.

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Side by side

HELOC vs cash-out refinance, rule by rule
The ruleHELOCCash-out refinance
What it isA home equity line of credit (HELOC) is an open-end credit plan secured by your home. The lender sets a limit against your equity, you borrow against it as you need to, and as you repay, that credit can become available to borrow again under the plan's terms. If you have a first mortgage, the line is a second mortgage behind it.A new first mortgage secured by the same home, larger than the one it replaces. It pays off the existing mortgage loans and pays you the difference in cash, which Fannie Mae's guide lets you use for any purpose. On a home with no mortgage on it, the new loan is the first.
What happens to your existing first mortgageIt stays as it is, under its own rate and terms. The line is paid in addition to it, and if the home is ever sold to pay off the debts, the first mortgage is paid first.It is paid off through the new loan. Fannie Mae requires a first mortgage being paid off to be at least as old as its guide sets, measured from the old note's date to the new one's; that age rule does not apply to subordinate liens being paid off, or to buying out a co-owner under a legal agreement.
How the money comes to youAs you draw on it: at the times and in the amounts you choose, up to the limit and within the plan's terms. What you repay can become available to borrow again.Once, at closing. The new loan pays off the old mortgage and whatever closing costs, points and prepaid items are financed in it, and the rest is disbursed to you.
The rateIt can change. On a variable-rate plan, the lender's disclosures must name the index the rate follows, say where you can find it, and explain how the rate is worked out from it, such as by adding a margin.The new loan's own rate, set in its note at closing. The Loan Estimate states it, and on an adjustable-rate loan it shows how and when the rate can change. The old loan's rate goes with the old loan.
How long you must have owned the homeNo federal rule sets a period. Whether to open a line, and on what, is decided under the lender's own underwriting criteria.At least one borrower must have been on title for the period Fannie Mae's guide sets before the new loan is disbursed, with exceptions: no ownership period is required when the lender documents that the borrower inherited the property or was legally awarded it in a divorce, separation or dissolution of a domestic partnership; the delayed financing exception covers a home bought recently without mortgage financing, on its own conditions; and time the property was held by an LLC the borrower majority-owns or controls, or by an inter vivos revocable trust with the borrower as primary beneficiary, can count. Fannie Mae buys loans on principal residences, second homes and investment properties, and its eligibility matrix sets the cash-out limits for each.
AppraisalThe lender decides how it values the home. The CFPB's booklet describes a line's limit as generally set against the home's appraised value less what you owe on your mortgage, and Regulation Z's freeze rule refers to the dwelling's appraised value for purposes of the plan.An appraisal, unless Fannie Mae's Desktop Underwriter offers value acceptance in its place. Value acceptance is considered only for certain cash-out refinances, on one-unit properties with an Approve/Eligible recommendation, and the lender must order an appraisal anyway where the law requires one or where it believes one is warranted, among other conditions.
What you must be givenThe lender's written disclosures of its plan and the federal brochure, What You Should Know About Home Equity Lines of Credit, or a suitable substitute, when you are given an application, or shortly after one taken by telephone or through a broker. The disclosures cover the plan's payment terms, its fees, the index and margin on a variable-rate plan, and the conditions on which the lender can change the plan.A Loan Estimate after you apply and a Closing Disclosure before closing, under Regulation Z's rules for a closed-end loan secured by real property: the loan amount, the rate, the projected payments, the closing costs and the cash to close, in the forms the regulation prescribes.
Your right to cancelOn a line secured by your principal dwelling, apart from narrow exceptions, you and any other owner whose principal dwelling it is may cancel the plan for a short time after it opens, until the date the lender's notice of the right gives. Unless the right is waived for a bona fide personal financial emergency, no money is released until that time has passed.The same right on a refinance secured by your principal dwelling, with one exception Regulation Z names: when the same lender refinances its own loan on the home, the right reaches only the new money above what was owed and the refinance's own costs. A loan that buys the home carries no right to cancel. Unless the right is waived for a bona fide personal financial emergency, no money is paid out until the period has passed.
Closing costsThe lender's disclosures must itemize the fees it imposes to open, use or maintain the plan, and estimate what third parties charge to open it, with an itemization on request. The CFPB's booklet advises weighing a line's up-front costs against how long you expect to keep the home, since a sale can require repaying the line in full.Closing costs, itemized on the Loan Estimate and the Closing Disclosure. Fannie Mae allows them, with points and prepaid items, to be financed in the new loan, and the CFPB notes that a cash-out refinance often carries closing costs.

Where each one fits

HELOC can fit when

  • You want to borrow as the need arises, over time, rather than in one sum, and to borrow again as you repay.
  • You want to keep your first mortgage as it is, under its own rate and terms.
  • You are confident of keeping up with the payments; the CFPB's advice is not to consider a line otherwise, because you could lose the home.

Read the HELOC page

Cash-out refinance can fit when

  • You know the amount now and want it once, at closing, with one mortgage payment afterward rather than a first mortgage and a line.
  • At least one borrower has been on title for the period Fannie Mae's guide sets, or fits one of its exceptions, and the first mortgage being paid off is old enough under the guide.
  • The home is a principal residence, a second home or an investment property, each of which Fannie Mae's guide allows.

Read the Cash-out refinance page

What the two have in common

  • Both are secured by your home, and falling behind on either could cost you the home through foreclosure.
  • Both borrow against your equity, which the CFPB defines as the value of your home minus the amount you owe on your mortgage.
  • Both carry a right to cancel for a short time when your principal dwelling secures them, with the exceptions each rule names, and no money is released until that time has passed unless the right is waived for a bona fide personal financial emergency.

Questions

What is the difference between a HELOC and a cash-out refinance?

A home equity line of credit (HELOC) is an open-end line of credit secured by your home that sits behind your first mortgage, which stays as it is; you borrow against it as you need to, and as you repay, that credit can become available again under the plan's terms. A cash-out refinance replaces your first mortgage with a new, larger one, pays you the difference in cash at closing, and puts the new loan's rate and terms in place of the old.

Can I pay off a HELOC with a cash-out refinance?

Yes. Fannie Mae's guide lists paying off any outstanding subordinate mortgage lien, of any age, among a cash-out refinance's acceptable uses. What the line was used for decides how the new loan is classed: a refinance that pays off a subordinate lien used entirely to buy the home can be treated as a limited cash-out refinance, if the lender documents that all of it went to the purchase, while paying off a line used for anything else makes the loan a cash-out refinance, with the cash-out rules and pricing.

Can I take cash out of a rental property?

With a cash-out refinance, Fannie Mae buys loans on investment properties as well as principal residences and second homes, with the cash-out limits for each set in its eligibility matrix. A home equity line of credit on a rental you do not live in is treated differently: Regulation Z deems credit to acquire, improve or maintain such a rental to be business credit, so the disclosures, the brochure and the right to cancel that come with a consumer line do not apply to it, and each lender decides whether it will open one.

If I open a HELOC now, can I still refinance my first mortgage later?

The CFPB warns that taking out a HELOC can affect your ability to refinance: you may have to get the line lender's approval to refinance the first mortgage, the lender can refuse, and if it does you may need to pay off the line in order to refinance.

Which costs less, a HELOC or a cash-out refinance?

Neither by rule. The CFPB says that, depending on the terms, a cash-out refinance may be more or less expensive than a HELOC, and tells you to weigh the new loan's rate against the one on your current mortgage. A line's costs are set out in the lender's disclosures, a refinance's on its Loan Estimate; read both before deciding.

Sources

The publications behind the rules above. Where a row says each lender decides for itself, no publication sets that rule. The figures for the county come from the county's loan limit page, with their own sources.

Keep reading:Every loan, comparedThe county's loan limits

Other comparisons:FHA vs conventionalFHA vs VAFHA vs USDAVA vs conventionalVA vs CalVetConventional vs jumboBank statement vs conventionalDSCR vs conventionalReverse mortgage vs HELOCDSCR vs bank statementBridge loan vs HELOC

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