HELOC vs. Cash-Out Refinance: Which Makes More Sense?

The most important difference: what happens to your first mortgage?

With a cash-out refinance, the new loan pays off the existing mortgage and provides additional cash, subject to closing costs and lender requirements. That means the interest rate and term on the entire refinanced balance can change.

With a second-lien HELOC, the original first mortgage remains. You take on a separate obligation with its own interest rate, payment and costs. For homeowners with an existing mortgage rate lower than today's available refinance rates, preserving that first loan may be appealing. But the HELOC's rate and fees still need to be evaluated carefully.

How to compare the actual costs

Compare these factors side by side:

• Current first mortgage: Would refinancing replace a rate or term you want to keep?
• New borrowing amount: How much additional cash do you actually need?
• Total monthly payment: With a second lien, add the first-mortgage payment and HELOC payment; with a refinance, consider the new mortgage payment.
• APR and fees: Include origination charges, financed costs and any other disclosed expenses.
• Years of repayment: Stretching repayment may lower a monthly payment while increasing total interest paid.
• Rate changes: Determine whether the offer is fixed, variable or has different rates for subsequent draws.

Avoid comparing only the advertised interest rates. The complete cost of borrowing can differ greatly from the headline rate.

A simple example of the decision—not a loan quote

Imagine a homeowner who owes $220,000 on a first mortgage and needs an additional $40,000. A cash-out refinance would generally create a replacement mortgage large enough to pay off the existing balance and provide the cash, plus applicable costs. A second-lien HELOC would generally leave the $220,000 first mortgage untouched and create a separate new obligation. Which is less costly depends on both offered loans, not simply the fact that one has a smaller balance.