HELOC vs. cash-out refinance

A  Home Equity Line of Credit (HELOC ) is another form of home equity financing. You’re still you’re borrowing against the  money already invested in your home, but instead of receiving a lump sum of money, you gain  access to credit against your current equity. A HELOC is like a credit card in that you have a  certain amount of money available to borrow and payback. You can take what you need when,  or if, you need it. You only pay interest on the amount you borrow.

HELOCs often begin with a lower interest rate than home equity loans, including cash-out refinancing loans, but the rate is adjustable, which means it can increase or decrease according to designated benchmarks. Of course, this means your monthly payment may increase or decrease as well.

A cash-out refinance  replaces your existing mortgage with a new home loan. You must have equity built up in your house to use a cash-out refinance.

Determining whether a HELOC or cash-out refinance is right for you is different for every individual, so it’s smart to compare your options to determine the right choice for you and your family.

Here are a few pros and cons for each method:

Cash-out refinance

Pros

• Interest rates tend to be lower than other options like HELOCs and home-equity loans.
• You have the flexibility to use the cash for anything you want, like home repairs, paying off high-interest credit cards, school tuition and more.
• The interest from your initial mortgage may be tax-deductible, depending on how it’s structured and where you live.
• There are multiple types of loans available with this process, with the term, fixed and variable rate options.

Cons

• Typically, a cash-out refinance will extend the timeframe for paying off your mortgage.
• Depending on the existing interest rate on your mortgage, you could end up with a higher interest loan and larger monthly payments.
• It’s possible that you may incur closing costs associated with refinancing, which generally range from 3% to 6% of the total refinanced amount.

Private Mortgage Insurance (PMI):

If you borrow more than 80% of your home’s value, you’ll have to pay for private mortgage insurance. For example, if your home is valued at $200,000 and you refinance for more than $160,000, you’ll probably have to pay PMI. Private mortgage insurance typically costs from 0.55% to 2.25% of your loan amount each year. PMI of 1% on a $180,000 mortgage would cost $1,800 per year.

Home Equity Line of Credit (HELOC)

Pros of a HELOC

• Closing costs tend to be lower with a HELOC than with a home equity loan or mortgage.
• You may be able to receive a tax break if your HELOC is used to improve your home, though you should first seek the advice of a tax professional.
• If you currently have a good interest rate, a HELOC will allow you to maintain that rate while still obtaining cash to use however you see fit.
• You can borrow up to 85% of the value of your home, versus 80% with a cash-out refinance.

Cons

• Interest rates tend to be higher with a HELOC than with refinancing your home.
• Unlike a 15- or 30-year mortgage, a HELOC typically comes with a much shorter term, anywhere from 5-10 years.
• You will be making two payments on your house versus one – your existing mortgage and your payment on the HELOC.
• With a variable interest rate versus a fixed-rate mortgage, your monthly payments may vary.

Making the Right Choice

You’re probably starting to get an idea of which type of financing fits your situation. Both forms  of refinancing can make sense if you can get a good interest rate on the new loan and have a sound use for the money.

Before deciding whether to apply for a HELOC or a cash-out refinance, consider how much money you really need and how you plan to use it. Factor in interest rates, fees, monthly payments, and tax advantages as you weigh your options.

Using the equity in your home wisely before selling can offer powerful financial benefits. Just be prudent and thorough in your decision making, and whenever possible, obtain advice and counsel from a professional in the mortgage industry.