Cash-out refinance mortgage or HELOC: Which is better?

There are several ways to use the value of your home to access cash. Two main ones are a cash-out refinance mortgage and a home equity line of credit, or HELOC.

Both options leverage your home equity, but a cash-out refinance replaces your existing mortgage with a new, larger one. A HELOC is a second mortgage with its own rate and term.

Here's what to know about how these loans work, their differences and which may be a better fit for you.

Cash-out refinancing allows you to convert your home equity into cash and take out a loan that is larger than your current mortgage.

If your home is worth $500,000 and you have $200,000 left on your mortgage, you could get a cash-out refinance loan for up to the full $500,000. Of that, $200,000 would go to pay off your existing home loan, leaving you with $300,000 to spend however you want.

With affordable rates and flexible credit score requirements, Rocket Mortgage is one of our top picks for a cash-out refinance.

Another top choice, Ally has a 100% online application and doesn't charge lender fees.

Approval requirements vary by lender, but to get a cash-out refinance mortgage you should have:

• At least 20% home equity
• A credit score of 620
• A debt-to-income ratio of 43% or less
• Verification of your income and employment

There are also restrictions on when you can refinance:

• For a conventional mortgage, you'll need to have owned your home for six months.
• A VA loan requires at least six monthly payments on your current mortgage and a refinance date at least 210 days after your first payment.
• For an FHA loan, you'll need 12 months' worth of on-time payments.

A home equity line of credit, or HELOC, is a second mortgage that lets you to borrow against the value of your property. While the amount of equity you can borrow against varies, it's typically capped at 85%.

Your HELOC will have a draw period, usually 10 to 15 years, in which you can tap your line of credit and are only required to make interest payments. After the draw period ends, you begin the repayment period and can no longer access your line of credit. You'll have a set amount of time (usually 20 or 30 years) to repay the remaining principal, plus interest.

Third Federal has affordable HELOC rates and doesn't charge closing fees, which can save you as much as 5% of your loan total. It also doesn't require a minimum draw, so you can spend as little as you want.

Rate promises approval for HELOCs in as little as five minutes and funding in as few as five days. Borrowers can borrow as much as  $400,000 with a competitive fixed rate.

HELOCs have similar requirements as cash-out refinancing and they also use your house as collateral — so your lender can force you into foreclosure if you fail to make payments.

While you have to wait at least six months from closing for a cash-out refinance, you can get a HELOC after owning your home for as little as 30 days. Some lenders promise your line of credit can be available just five days after you apply.

While they both leverage your home equity, these two financing options have some major differences.

Availability

While most mortgage lenders offer cash-out refinancing, the number with home equity lines of credit has declined in recent years. Only half of the providers on our best mortgage lenders list offer HELOCs.

Requirements

Refinancing typically requires 20% equity, while lenders will approve borrowers with 15% for a HELOC. Some lenders will accept a credit score of 580 for a cash-out refinance, while a HELOC typically requires a score of between 620 and 680.

For either a cash-out refinance or a HELOC, most lenders prefer a DTI ratio of 43% or lower, though some may go up to 50%.

Interest rates

A cash-out refinancing can be either a fixed or adjustable rate mortgage, depending on which suits your needs. HELOC loans are usually variable, though you may be able to convert all or part of your balance to a fixed rate during the draw period.

Cash distribution

With a cash-out refinance, you'll receive the money in one lump sum. It may take up to 60 days to complete the process, including scheduling the appraisal.

A HELOC can usually be completed in under six weeks and, since it's a revolving line of credit, you can make numerous withdrawals during your draw period.

If you're trying to decide whether a HELOC or a cash-out refinance is a better option, ask yourself several questions:

What's happening with mortgage rates? If rates have dropped since you took out your original mortgage, a cash-out refinance could let you switch to a better rate or change your term length. A HELOC is a second mortgage and doesn't affect the loan you're already paying.

How soon do you need the money? A cash-out refinance is a mortgage and it can take up to two months for you to receive the funds at closing. A HELOC, on the other hand, can be obtained in weeks or even days.

How much do you need? Rates on HELOCs tend to be higher, but the fees are usually lower. (Your lender may even waive some fees if you borrow enough or keep the line of credit open long enough.) Calculate the total cost of both options to see which is more cost-effective for you.

What do you need the money for? If you need a specific amount for a one-time expense, like buying a car or paying off high-interest credit cards, cash-out refinancing may be the better choice. If you have ongoing expenses or you're not sure how much you'll need — for long-term renovations or medical bills, for example — a HELOC may be a better fit.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every mortgage review is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

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