Cash Out vs. HELOC vs. Home Equity Loan: Which Is the Best Option Right Now and Why?

With the current state of the economy and the belief that a recession may be right around the corner, you might be interested in leveraging some of the equity you’ve built up in your home. In this situation, you could get cash by borrowing against this equity. There are several different loan types at your disposal, which include a cash-out refinance, a HELOC, and a home equity loan.

What Is a Cash-out Refinance?

A cash-out refinance is a completely new loan that’s designed to replace your current mortgage with a new one that’s higher than the outstanding balance you have on your current loan. Once the closing process takes place, you’ll receive the difference between your old loan and new one in a lump sum payment.

This option might be right for you if you’d like to obtain cash and refinance your mortgage at the same time. The main issue with a cash-out refinance is that you might pay a higher amount of interest over the course of the repayment period if interest rates have risen since obtaining your original mortgage. In the event that your home equity drops below 20% following the refinance, you might be required to start paying for private mortgage insurance.

What Is a HELOC?

A home equity line of credit (HELOC) is an open line of credit that you can access whenever you need it. This line of credit has almost the same functions as a credit card. However, HELOCs have some advantages when compared to credit cards. For one, your balance should be much higher than what it is with a credit card. Your interest rates should also be lower. This type of loan must still be taken through the underwriting process since your equity is being used as collateral for the loan.

A HELOC usually comes with a variable interest rate as well as an initial draw period that’s able to last for as much as 10 years. Throughout the initial draw period, your payments will solely go towards the interest you owe. Once this period comes to an end, you’ll need to repay the principal of the loan as well as any remaining interest.

The main benefit of a line of credit is also its most notable drawback. While many homeowners prefer lines of credit that allow them to draw from the credit whenever it’s needed, some homeowners make the mistake of using more money that they require, which can be an issue once it comes time to repay the loan.

What Is a Home Equity Loan?

Home equity loans involve lump sum payments that provide you with a specific sum of money. This is considered to be an additional mortgage and won’t affect your current one. The money you borrow must be repaid over a period of around 5-30 years with a fixed interest rate.

Keep in mind, however, that the interest rate you obtain for a home equity loan will likely be higher than what you receive with a cash-out refinance. Since you’re taking on a completely different mortgage, the lender is also taking on more risk by providing you with the loan.

What Your Best Option Is Right Now

Taking out any type of loan is going to be a risky decision. Because of the possibility of a recession, it’s highly recommended that you take time to weigh the pros and cons of each option available to you.

Home equity loans provide you with all of the funds immediately, after which the loan is repaid at a fixed interest rate. If you’re able to qualify for a low interest rate, this could be a great option for you.

HELOC loans allow you to obtain funds from the line of credit whenever necessary. Repayment doesn’t begin until the initial draw period ends. While these loans come with risky variable interest rates, your lender might give you the opportunity to lock in a specific rate.

As for a cash-out refinance, this solution may be good for you if you need access to cash and are thinking of refinancing. Your existing mortgage will be replaced with a new one alongside an extended term.

If you decide to borrow against the equity in your home, it’s essential that you’re able to afford the repayment. If you’re unable to make these payments on time, your home could be foreclosed on. Now that you understand what your options are, you should be ready to select your preferred solution.