You need money and you need it now. But how are you going to get it? Have you thought about accessing your home equity? If you’re looking to have some extra cash on hand, a cash-out refinance or home equity line of credit (HELOC) may be the way to go. But which is better?
That depends on a few factors, including your personal situation. But we want to make your money work for you by giving you the rundown on each. So here’s what you need to know about cash-out refinance vs. HELOC.
A cash-out refinance (or any refinance) could be an opportunity for you to secure a lower interest rate. This is especially true if mortgage interest rates have dropped since you originally closed on your home.
Even if you can’t secure a lower interest rate, a cash-out refi may offer a lower interest rate than a HELOC. Since HELOCs are often second mortgages, they take second priority should you ever default on your loan.
This means, should your home enter foreclosure, your first-priority lender will be able to recoup any money owed first. The second-priority lender will come second. That generally makes second mortgages a higher risk for lenders, which means they typically come with a higher interest rate.
A cash-out refinance enables you to have complete control of your loan type and terms. For instance, you can choose between a fixed-rate or an adjustable-rate mortgage. You can also choose your loan term, such as 15 or 30 years for repayment. Cash-out refinanceing gives you more options than a HELOC so you can choose the type of loan that’s right for you.
When you choose to do a cash-out refinance, you will have a single monthly payment. Rather than having to keep track of more than one due date (and possibly missing a payment), you can keep your finances simple and easily manageable. If you really want to streamline your payments, you could use the extra cash to pay off and consolidate debt.
Before you close on a cash-out refinance, you should be sure it is financially worth your while. For instance, you may incur prepayment penalties if you pay off the mortgage early. Find out from your lender if a prepayment penalty will be assessed and, if so, how much it will cost you.
Speaking of costs, you’ll also have to factor in the cost of your new mortgage to determine whether a cash-out refi is really a good option. Even if you qualify for a lower interest rate, a cash-out refi could cost you more overall once you factor in loan closing costs. You can expect closing costs to run about 3 to 5 percent of the total loan amount.
The other downside to a cash-out refi is that it could also put you further away from paying off your loan in full. For instance, if you close on a 30-year mortgage, pay it down for 10 years, and then refi for a new 30-year mortgage, you’ve just extended your loan payoff for another 10 years.
You’ve essentially hit the reset button on your loan. On the other hand, if you close on a second mortgage with the same loan term or a shorter one, you can stay on track and pay off your home as originally scheduled.
HELOCs offer great flexibility. If you’re unsure of how much money you’ll need to borrow, you can borrow as much as you’re qualified for or as little as you need. HELOCs operate similarly to a credit card in the sense that you can borrow against the line of credit, pay it back, and then borrow again for as long as the draw period lasts.
Most lenders will only allow you to borrow up to 80 percent equity with a cash-out refinance. But when you close on a HELOC, you may be able to borrow as much as 85 percent of your home’s value. If you need more access to cash, a HELOC may be the way to go.
But be careful. When you borrow more, there’s a greater chance you could go into foreclosure or wind up owing more than your home is actually worth should property values drop.
If you’re looking to save money up front but expect to be in a better financial situation down the line, then a HELOC may be the better option. HELOCs are structured in such a way that you can make interest-only payments during the draw period. You won’t be expected to pay back any of the principal until the repayment period begins. If you know you’ll be in a better financial position in the future, then a HELOC could be just what you need to bide some time until your financial situation improves.
Because HELOCs typically come with higher interest rates, your monthly payments may be higher. But again, you should do a cost comparison with your preferred lender. The closing costs on a cash-out refinance could mean you’ll wind up saving more money with a HELOC, even if your interest rate is slightly higher.
Another thing that will likely contribute to higher monthly payments is that HELOCs usually have shorter loan terms. For instance, you may have a 5-year draw period followed by a 15-year repayment period. While you may be able to opt for a 30-year loan term with a cash-out refi, a HELOC will likely have to be paid back over a shorter period of time.
HELOCs have a variable interest rate. That means your monthly payments will fluctuate based on market conditions. If you prefer consistent monthly payments, you may find that a cash-out refi is the better option.
Still have questions about a cash-out refinance vs. a HELOC? The team at Solarity Credit Union can help. They can review your personal situation and your needs and assist you in determining which is the better option for you. Whether you want to make home improvements, consolidate debt, or buy an investment property, Solarity can get you on the right path to future financial success.