HELOC VS Refinance – the clash for cash
If you need to access cash from your home equity and have no interest in selling, in most cases you’re left with limited options to tap into the equity you’ve likely grown over the past few years of high appreciation. It often boils down to a HELOC VS Refinance. There are some definite benefits and drawbacks to both options so it’s important to know the ins and outs so you can make a smart financial decision that offers the most benefits short and long term. Let’s start with the HELOC!
HELOCs are Home Equity Lines of Credit. They act similarly to a credit card, in that you have a limit (based on the amount of equity in your home), and can access the line of credit to draw funds in either a lump sum, or as needed, during a “draw period”. Most HELOCs are structured as 30 year loans, with an initial 10 year “draw period” where you can access the cash from your home, followed by a 20 year repayment period in which no more cash can be taken out and the withdrawn funds must be repaid. During the draw period, most HELOCs offer interest-only payment options.
The plus side of this payment option is that it allows for lower monthly payments so you can borrow the money you need for things like debt consolidation, home renovations, or anything else, without making too large of an impact to your monthly budget. Another perk of HELOC products is they often have lower closing costs than a full refinance, but many times they will be accompanied by a small annual fee (again, similar to many credit cards).
The HELOC is not without it’s downside. Since HELOCs tend to be based on the prime rate, the interest rate is often variable based on what the Fed does to the Fed funds rate. Unlike first mortgage rates, HELOC rates vary, sometimes frequently, so payment amounts aren’t fixed and can be unpredictable year over year. Another downside that’s not often considered is that if you want to refinance your first mortgage in the future and you have a HELOC, most times your new refinance rate will be higher as there’s a penalty for having a 1st and 2nd lien, but also a penalty for “cash out” if you’re consolidating a HELOC that wasn’t used to purchase your home.
So while HELOCs may be a more affordable option up front, they could prove more costly long term in the event rates rise, and they’ll make future refinances (to take advantage of lowering rates) more expensive
A refinance is a restructuring of an existing mortgage lien, in which a new loan replaces the existing loan. With a cash out refinance (often referred to as an “equity loan”), borrowers may restructure their existing debt and borrower additional funds from the equity in their home as well. A refinance can also be used to simply reduce an existing interest rate or change the term of a loan (for example, from a 30 year to a 15 year loan term). When no additional cash is borrowed, or only a very small amount, it’s called a “rate/term refinance”, or “no cash out refinance”.
The perks of a refinance to take cash out will depend on the situation, but fixed rates are available so a borrower knows what their payment will be today, 6 months from now, and for years to come. This offers more long term planning without having to worry about rates or the overall mortgage market in terms of the effect on monthly payment and finances. A refinance may also offer the possibility for more cash out, and is available on various property types and ownership situations (for example, HELOCs aren’t widely available in investment properties, but investment property owners frequently borrow against their equity with refinances). In a falling rate environment, refinancing can sometimes offer customers cash without impacting their monthly expenses! For example, on a $400,000 mortgage at 5.5%, the monthly payment is close to the same as a $500,000 mortgage at 3.5%, so in a falling rate environment, a refinance can offer cash without negatively impacting your budget!.
The downside of a refinance is that if you currently have a very low interest rate, increasing it by much to access cash may be a tough pill to swallow. It can make sense when paying off higher rate consumer debt, but whether it’s worth it depends on overall savings. Refinance closing costs tend to be higher than HELOC closing costs, too, sometimes by a few thousand dollars.
When it comes to the HELOC VS Refinance debate, everyone’s situation is different and since both products offer different short and long term benefits and pitfalls, it’s really important to talk with an expert about the available options. Our MasonMac loan officers are here and ready to help you decide – when it comes to HELOC vs Refinance, what’s right for you?