Home values across most parts of the country have not only recovered from their lows in the early part of this decade but the continued increase in home prices also adds to homeowner wealth in the form of equity. Increasing equity and low rates typically signal an opportunity to tap into that equity and put some extra money in the homeowner’s pockets. There are two primary ways to access that equity with a cash-out refinance and a Home Equity Line of Credit, or HELOC. So, if there are two choices which one is best for you?
HELOC: How it Works
Let’s look at the HELOC first. A HELOC is essentially a line of credit that acts very much like a regular credit card. The HELOC will have a credit line and the homeowners can pull funds from that credit line to do with whatever they choose. Each month they can pay back all or part of the amount drawn. Paying down the HELOC balance means that later on the homeowners can take advantage of this low-cost method of borrowing whenever funds are needed or wanted. A HELOC comes in the form of a second mortgage and is a lien secured by the property. There are no restrictions regarding what the funds can be used for. For example, homeowners can use the funds to pay off high interest credit card debt, student loans or to pay off an automobile loan. Interest rates on HELOCs are of the adjustable rate variety.
Benefits of Cash-Out Refinance
A cash out refinance can also provide additional funds in a homeowners pocket during the course of a refinance. When someone decides it’s time to refinance they might also consider pulling out cash at the closing table. For example, a property is currently appraised at $300,000 and the owners have a mortgage balance of $175,000. They have a hybrid loan that is set to adjust in a few months so they decide to take advantage of today’s fixed rates and switch from the hybrid to the stability of a fixed rate. But they also want to take out some funds for a complete remodel of the kitchen. They add together the mortgage amount of $175,000, closing costs of $3,000 and an additional $25,000 for the remodel. The new mortgage will be $203,000.
So, which is better, the HELOC or a cash-out refinance? If all someone wants to do is to tap into their equity then a HELOC might be the better option. A HELOC is a low-cost mortgage with very few fees and competitive rates. Due to the low fees involved and they’re satisfied with their current mortgage, the HELOC is the better choice. One important note however, interest on HELOCs is no longer tax deductible beginning this year and going forward but there are no changes regarding deductibility with a cash out refinance.
If someone decides it’s time to refinance but also wants to pull out some cash, then the cash-out route is the ideal option. A cash-out refinance is a brand new mortgage and there will be closing costs involved, more than what is needed for a HELOC. If someone just wants some extra cash in the bank, the HELOC takes the nod.