How to Determine If You're Better Off Refinancing or Getting a HELOC
A cash-out refinance and a HELOC can both help you generate funds for home improvements and other big purchases. However, it's tough to know which one is the best for your unique situation. We'll do our best to help you sort it out.
Refis and HELOCs: What's the Difference?
To start with, it’s important to note how cash-out refis differ from HELOCs. With a cash out refinance, you get a fat check at the loan’s closing, but only the one. Once you've used the cash to renovate your bathroom or build that deck you've been dreaming of, the cash is gone.
Closing a HELOC, on the other hand, establishes a credit line that you can use with a card. It works just like a credit card: you have a limit that’s equal to the amount you’re tapping with your loan, and you can tap it as frequently as you want, provided you have enough available balance. When you pay it down, that amount of money is credited to your HELOC and you can spend it again.
Because the two function so differently, they each kind of have their own strengths. A standard mortgage refinance is great for one-time needs, whether that’s to pay the general contractor who is fixing up your kitchen or to get rid of college debt.
HELOCs are awesome for chronic do-it-yourselfers, who often spend each weekend of a project standing in long lines at home improvement stores. They need flexible, ongoing access to their equity and a HELOC provides that.
The cons of any sort of home equity loan are pretty much the same. You’re literally borrowing the home equity you’ve accumulated and creating a secondary mortgage that must be repaid. If you don’t repay it, you could lose your house to foreclosure. If the market takes another nosedive, you could be underwater pretty quickly. It’s not a decision to make lightly.
HELOCs are problematic for some types of consumers. Just like a credit card, you can burn through the credit line quickly if you’re not paying good attention. They also generally have an adjustable rate, which can hurt you when the Fed is talking rate hikes. If you opt for the HELOC and max it out without a plan in mind, you could easily find yourself with a payment you can't make.
Now on the other hand, you’ve got a one-time cash out refinance. In general, you’re going to increase the debt you owe on your home, which, as noted above, can be painful in the long run. Depending on how much extra you borrow, you may be subject to mortgage insurance again. You also reset your loan, so to speak.
Let’s say you’ve been paying faithfully for 10 years and you can kind of see retirement in the far distance. Well, that refinance (unless you’ve jumped to a 10, 15 or 20 year product) is going to reset you. You’re back to the beginning of a 30 year mortgage, and you’ll pay a lot of interest for the first five or so years before you start to really touch the principal. And of course, your payment will be higher than your old one.
Refinancing in 2018
Frankly, these days a refinance doesn’t make a lot of sense unless a homeowner is desperate or selling soon. With rates going up, the chances are good that you've currently got a better rate than you can get with a refinance. So, in that way, the HELOC or a standard home equity loan is the better bet for the money.