Is It Better to Get a HELOC or Refinance?

Homeowners often consider a Home Equity Line of Credit (HELOC) or a mortgage refinance to access funds or adjust loan terms. Both options serve different financial goals. Understanding their functions is key to making an informed decision.

Understanding Each Option

A Home Equity Line of Credit (HELOC) is a revolving line of credit secured by your home’s equity. Like a credit card, it allows borrowing funds as needed, up to an approved limit, during a “draw period” (often 10 years). Payments during this period may be interest-only. After the draw period, a “repayment period” (typically 10-20 years) begins, requiring principal and interest payments. A HELOC is a second mortgage.

A mortgage refinance replaces your existing home loan with a new one, potentially with different terms like a lower interest rate or altered repayment period. A “cash-out refinance” allows you to borrow more than your current balance, receiving the difference as a lump sum. This new loan pays off the old one, becoming your primary mortgage. Refinancing can reduce interest costs, lower monthly payments, or consolidate debt.

Key Distinctions

A HELOC offers a flexible, revolving credit line, allowing borrowers to draw, repay, and redraw funds during the draw period. Conversely, a refinance, especially a cash-out refinance, provides a single, lump-sum disbursement at closing. No further borrowing is possible from a refinance without a new loan process.

Interest rates differ significantly. HELOCs typically have variable rates, fluctuating with an index like the U.S. Prime Rate, leading to changing monthly payments. While some HELOCs offer fixed-rate conversion options, variable rates are standard. Refinances commonly offer fixed interest rates for the loan term, providing predictable monthly payments, though adjustable-rate mortgages (ARMs) are also available.

A HELOC is generally a second lien, subordinate to your primary mortgage. In a foreclosure, the primary mortgage lender is paid first from the home’s sale. A refinance replaces your existing primary mortgage, making the new loan the first lien.

Costs vary between options. HELOC closing costs typically range from 2% to 5% of the line of credit. Some “no-fee” HELOCs may have higher interest rates. Refinance closing costs are generally higher, 2% to 6% of the new loan amount, including appraisal, origination, and title fees. These costs are paid upfront or rolled into the new loan.

Repayment structures also differ. A HELOC has two phases: a draw period for accessing funds, often with interest-only payments, followed by a repayment period requiring principal and interest payments. A refinance begins with immediate principal and interest payments on the new loan, following a fixed amortization schedule.

Choosing the Right Approach

Choosing between a HELOC and a refinance depends on your financial goals and market conditions. For intermittent access to funds for ongoing projects or emergencies, a HELOC is suitable. Its revolving nature offers flexibility without reapplying. However, variable interest rates can lead to unpredictable monthly payments if market rates increase.

For larger, one-time expenses like a substantial home renovation or consolidating high-interest debt, a cash-out refinance often aligns better. It provides a lump sum, and the new fixed-rate mortgage offers stable, predictable monthly payments. This predictability is advantageous, especially with rising interest rates.

Creditworthiness and home equity are important factors. For a HELOC, lenders typically require a credit score of at least 620 (700+ for better rates), 15-20% home equity, and a debt-to-income (DTI) ratio below 50%. A conventional refinance usually requires a 620+ credit score, though some programs accept 580. A cash-out refinance typically requires at least 20% equity remaining and a DTI ratio below 43%.

Tax implications warrant consideration. Interest on both HELOCs and refinances can be tax-deductible if funds are used to buy, build, or substantially improve the home. For loans originated after December 15, 2017, the deductible interest limit applies to combined mortgage debt up to $750,000 ($375,000 for married filing separately). This deduction requires itemizing. If funds are used for other purposes, like debt consolidation or personal expenses, interest is generally not tax-deductible. Consult a tax professional for specific deductibility.

Consider your risk tolerance and time horizon. If comfortable with interest rate fluctuations and needing funds intermittently, a HELOC’s variable rate and flexible draw may suit you. If stable monthly payments and a single, predictable disbursement for a long-term goal are priorities, a fixed-rate refinance offers more financial security. Assess your financial circumstances and consider seeking guidance from a financial advisor.