VA Cash Out Refinance vs HELOC: Comparing Total Borrowing Costs Over Five Years

Homeowners who need money for home improvements, debt consolidation, major expenses, or other financial goals may consider using their home equity. Two common options are a cash out refinance and a home equity line of credit, also known as a HELOC.

Both options allow homeowners to borrow against the equity they have built in their property. However, they work differently and can produce significantly different borrowing costs over five years.

A cash out refinance replaces the existing mortgage with a new, larger mortgage. A HELOC generally keeps the existing mortgage in place and adds a separate credit line secured by the home. The better option depends on the current mortgage rate, the amount of money needed, closing costs, repayment terms, and expected interest rate changes.

Understanding the difference between cash out refinance vs HELOC financing can help homeowners compare the total cost rather than choosing an option based only on the advertised interest rate.

What Is a Cash Out Refinance vs HELOC?

What Is a Cash Out Refinance?

A cash out refinance replaces an existing mortgage with a new mortgage for a larger amount. The new loan pays off the existing mortgage, and the remaining amount is provided to the borrower as cash after applicable costs.

For example, suppose a homeowner owes $250,000 on a property and qualifies for a new mortgage of $300,000. Before accounting for closing costs and other adjustments, the difference is $50,000.

The borrower receives access to that equity but also takes on a new mortgage balance, interest rate, and repayment term.

A cash out refinance may be worth considering when a homeowner needs a large lump sum and the new mortgage terms are financially competitive with the existing loan. However, replacing a low rate mortgage with a higher rate can increase the cost of borrowing across the entire refinanced balance.

What Is a HELOC?

A home equity line of credit is a revolving credit line secured by the homeowner's property. Instead of replacing the existing mortgage, a HELOC generally adds a second loan obligation.

The lender approves a credit limit, and the homeowner can draw funds as needed, subject to the agreement. As the borrower repays the outstanding balance, available credit may become available again.

Many HELOCs have variable interest rates. Payments can change when rates change, and the payment structure may also change when the draw period ends and the repayment period begins. Some lenders offer fixed rate conversion options for eligible balances.

The Consumer Financial Protection Bureau explains that HELOCs can involve fees, variable interest rates, and higher payments when the repayment period begins. Homeowners should review these terms before opening a credit line.

Cash Out Refinance vs HELOC vs Home Equity Loan

A home equity loan is another option for homeowners who want to access their property's equity. It provides a lump sum that is repaid according to a separate loan agreement.

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The key distinction is that a cash out refinance changes the terms of the entire mortgage, while a HELOC or home equity loan generally leaves the existing first mortgage in place. Actual eligibility, costs, and repayment terms vary by lender and loan program.

How to Compare Total Borrowing Costs Over Five Years

Comparing only the interest rates can produce a misleading result. A five year comparison should account for interest, closing costs, ongoing fees, principal repayment, and the value of keeping the current mortgage.

Consider a homeowner with an existing mortgage balance of $250,000 who needs $50,000 in additional funds.

For illustration, assume the following terms:

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These are hypothetical assumptions, not current rate quotes or a personalized loan estimate. For the HELOC example, the calculation assumes the full $50,000 is drawn immediately and repaid through principal and interest payments over 20 years. The variable rate is assumed to remain unchanged for the illustration.

Why the Existing Mortgage Rate Matters

The example above does not specify the interest rate on the existing $250,000 mortgage. That rate is essential when deciding whether refinancing makes financial sense.

If the current mortgage has a 3.50% rate, refinancing the entire balance at 6.75% could increase interest costs on the existing $250,000 debt. A HELOC might preserve the lower first mortgage rate, even though its rate on the additional borrowing is higher.

If the existing mortgage rate is already close to or above the proposed refinance rate, the cash out refinance may become more competitive.

Comparing Five Year Interest Costs

Under the hypothetical assumptions above, the new $300,000 mortgage at 6.75% over 30 years has an estimated principal and interest payment of about $1,946 per month.

The $50,000 HELOC at 8.50%, amortized over 20 years, has an estimated payment of about $434 per month. The existing mortgage payment continues separately.

Over 60 months, the cash out refinance would generate approximately $116,800 in total principal and interest payments. The HELOC would generate approximately $26,000 in payments, in addition to the existing mortgage payments.

These payment totals are not a like for like measure of borrowing cost. The refinance payment covers both the existing mortgage balance and the new cash, while the HELOC payment covers only the additional $50,000. A fair comparison must include the existing mortgage payments under the HELOC option and separate interest from principal repayment.

To isolate the cost of borrowing the additional $50,000, a simplified comparison of the new debt can be useful. At the assumed terms, the additional borrowing represented by a cash out refinance has a higher initial balance and a different repayment schedule from the HELOC. The five year cost should therefore be evaluated using the interest paid, upfront costs, and remaining balances at the end of the period.

The central lesson is that the lowest monthly payment does not automatically represent the lowest total cost.

Which Costs Should You Include?

A complete five year comparison should include the following factors.

1. Interest on the Existing Mortgage

With a cash out refinance, the entire mortgage is repriced under the new loan terms. If the current mortgage has a lower interest rate, the cost of refinancing that existing balance can outweigh savings on the additional funds.

With a HELOC, the original mortgage rate generally stays the same. The borrower pays interest on the separate HELOC balance.

2. Closing Costs and Fees

Cash out refinancing may involve lender fees, appraisal costs, title services, recording charges, and other settlement expenses.

HELOCs may involve application, appraisal, title, annual, inactivity, or early termination fees, depending on the agreement. Some lenders reduce or waive certain costs, so borrowers should compare actual written estimates.

3. Variable Interest Rate Changes

A HELOC's variable rate can rise or fall during the five year period. If rates rise, the interest expense and monthly payment may increase. If rates fall, the borrowing cost may decrease, depending on the agreement.

A fixed rate cash out refinance provides more predictable principal and interest payments during the fixed rate period. An adjustable rate refinance has different risks and should be evaluated separately.

4. Principal Repayment and Remaining Balance

Principal repayment is not the same as an interest expense. When comparing loans over five years, calculate both the amount paid and the remaining loan balance at the end of the period.

A loan with a lower payment may leave more principal outstanding. A HELOC with interest only payments during the draw period, for example, may cost more over time if the borrower does not make principal payments.

5. The Cost of Replacing a Low Rate Mortgage

This is often the most important factor. A homeowner with a very low existing mortgage rate may be better served by borrowing only the additional amount through a HELOC or home equity loan. A cash out refinance may still be appropriate in some circumstances, but the impact on the full mortgage balance must be included in the calculation.

When Does a Cash Out Refinance Make More Sense?

A cash out refinance may be worth considering when:

1. The new mortgage rate and terms compare favorably with the existing mortgage.
2. The homeowner needs a substantial lump sum.
3. The estimated interest savings or other financial benefits justify the closing costs.
4. The homeowner prefers one consolidated mortgage payment.
5. The borrower expects to keep the new mortgage long enough for the overall financial benefits to justify the transaction costs.

The decision should be based on the complete loan estimate and the borrower's expected time in the property, rather than on the new rate alone.

When Does a HELOC Make More Sense?

A HELOC may be more suitable when:

1. The homeowner wants to preserve a favorable existing mortgage rate.
2. Expenses will occur over several months or years.
3. The homeowner wants access to funds without borrowing the entire amount immediately.
4. The borrower can manage potential payment increases from a variable rate.
5. The total cost of the HELOC is lower after accounting for fees, interest, and the existing mortgage.

A HELOC is not automatically cheaper. Borrowers should understand the draw period, repayment period, minimum payment, rate caps, and circumstances in which the lender may restrict further borrowing.

What About VA Cash Out Refinance Options?

Eligible veterans may consider a VA cash out refinance to replace an existing mortgage and access home equity. Eligibility, available loan terms, costs, and the amount of equity that can be accessed depend on applicable VA requirements and lender underwriting.

Veterans comparing a VA cash out refinance with a HELOC should consider the existing mortgage rate, the proposed VA loan terms, closing costs, any applicable VA funding fee, and the HELOC's rate and repayment conditions.

The comparison should also account for how the new loan affects the full mortgage balance. A VA cash out refinance should not be selected simply because it offers access to cash or a particular loan feature. The full five year cost and longer term financial impact matter.

Five Year Borrowing Cost Checklist

Before making a decision, request written estimates for both options and compare:

• The current mortgage balance and interest rate
• The total amount of additional cash required
• The proposed refinance balance and interest rate
• The HELOC credit limit, initial draw, and rate structure
• All lender and third party closing costs
• Monthly principal and interest payments
• Potential variable rate increases
• The total interest paid during the first five years
• The remaining principal balance after five years
• Any fees for early termination, conversion, or repayment
• The expected time you will keep the home and the loan

This approach makes the comparison more useful than relying on a headline interest rate or a single monthly payment.

Frequently Asked Questions

1. What is the main difference between a cash out refinance and a HELOC?

A cash out refinance replaces the existing mortgage with a larger mortgage and provides the difference in cash. A HELOC generally leaves the original mortgage in place and adds a separate revolving credit line secured by the property.

2. Is a cash out refinance cheaper than a HELOC over five years?

It depends on the existing mortgage rate, new refinance rate, HELOC rate changes, closing costs, repayment structure, and remaining balances. A refinance may be more competitive when the new terms are favorable, while a HELOC may be preferable when preserving a low first mortgage rate is important.

3. Does a HELOC affect my current mortgage rate?

A HELOC generally does not change the interest rate on the existing first mortgage. It creates a separate debt obligation, and the homeowner must make payments on both loans.

4. Is a HELOC interest rate fixed or variable?

Most HELOCs have variable interest rates, although some lenders offer fixed rate options or allow portions of the balance to be converted to a fixed rate. Review the lender's rate adjustment terms and payment disclosures.

5. Is a home equity loan different from a HELOC?

Yes. A home equity loan typically provides a lump sum with scheduled repayments. A HELOC provides access to a credit line that can generally be drawn and repaid during the draw period, subject to its terms.

6. Can veterans use a VA cash out refinance to access home equity?

Eligible veterans may be able to use a VA cash out refinance if they meet applicable VA and lender requirements. Eligibility, costs, loan terms, and the amount available depend on individual circumstances.

7. What is the biggest mistake when comparing these options?

Comparing only the interest rate or monthly payment. Homeowners should also evaluate closing costs, interest on the existing mortgage, rate changes, principal repayment, and the remaining loan balance after five years.

Conclusion

Choosing between a cash out refinance vs HELOC requires more than comparing advertised interest rates. A cash out refinance replaces the existing mortgage and may be suitable when the new terms justify the cost. A HELOC generally preserves the current mortgage and provides flexible access to additional funds, but its variable rate and repayment structure can create uncertainty.

For a meaningful five year comparison, calculate the total interest paid, upfront and ongoing fees, principal repaid, and remaining balance under both options. Homeowners should also consider a home equity loan when they need a known lump sum without replacing their existing first mortgage.

Merchants Home Lending can help borrowers understand the mortgage options available to them and compare loan terms in the context of their financial goals.

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