Homeowners who have built up significant equity often leverage that value with a Home Equity Line of Credit (HELOC) or a Cash-Out Refinance. Which of these two options is better? That depends on your circumstances. Learn more about the differences between the two so you can make an informed decision.
Buying a home is a good investment in large part because your monthly mortgage payment helps you build free-and-clear ownership, or equity in your property. This equity is valuable if you sell the home, but you can also stay put and make use of your ownership.
That’s where a HELOC or Cash-Out Refi becomes useful. Let’s say your living room was lined with dated wood paneling when you bought your house 10 years ago. You intended to replace that paneling with something fresher soon after buying, but never had the extra cash. Now that you’ve been paying off your mortgage for 10 years, you own enough value in your home to finance that living room rehab project.
Weighing Your Options
When you have the equity available, there are a few different ways to take advantage of it. Selling is one common way of cashing in on equity, but if you want to keep your house, there are other options. HELOCs and Cash-Out Refis are two such options, each with its own unique character. Once you understand the basics, get in touch with a Directors Mortgage team member to learn more about which option might be best for your specific circumstances.
A Home Equity Line of Credit, or HELOC is a revolving credit account that’s secured by equity. Sources often compare HELOCs to credit cards, and though that’s a good basic comparison, there are some important differences between the two:
HELOCs typically have much lower interest rates than credit cards
HELOCs are available for a finite period of time
That time is split into two phases: a draw period and a pay period
HELOCs are secured by collateral in the form of home equity
One important thing to be aware of: the fact that most HELOCs have separate draw and pay periods doesn’t mean you will be able to spend without making any payments until the pay period. You’ll be required to make payments during the draw period as well—depending on the terms of your HELOC, these may be interest-only payments. The pay period allows you time to repay the balance of your HELOC if you’ve maxed it out.
Note, too, that with a HELOC, you keep your original mortgage. Nothing about that will change. The HELOC is a separate entity, and so you’ll need to make payments in addition to your mortgage.
The Bottom Line: If you’re happy with your current mortgage terms and rate, and you have exercised good discipline with credit cards or lines of credit in the past, a HELOC may be the right choice for you.
Cash-Out Refinance Basics
Refinancing, or Refi, is a common practice among people who hold mortgages. When you Refi, you can secure more favorable terms for your mortgage than you initially had. For example, when interest rates are exceptionally low (as they have been recently), you can refinance out of an adjustable-rate mortgage into a fixed rate to lock in a favorable rate for the entire duration of your loan.
With a Cash-Out Refi, you not only swap your old mortgage terms for new ones but also cash out on the equity you’ve built up. That means:
You’ll receive a lump-sum payment of equity value
Your old mortgage will be replaced with a new one reflecting current interest rates
You’ll sign a new mortgage, meaning you’ll need to pay closing costs
Your monthly mortgage payment will likely change based on your new mortgage terms
In that sense, a Cash-Out Refi can be a bit more of a commitment than a HELOC. You’ll be taking on a new mortgage to replace your old one, and that could mean that your monthly budget changes. That’s not necessarily a bad thing—again, it’s entirely possible you could refinance into better terms than you had before.
The Bottom Line: If you want a lump sum and better mortgage terms, a Cash-Out Refi might be the right choice for you. Just be careful in considering the impact the new mortgage might have on your short- and long-term budgets.
How We Can Help
Keep in mind that these are not the only two options available for those who want to use their home’s equity to improve their current financial situation. For those age 62 and up, a Reverse Mortgage may be an even better option than either HELOC or Cash-Out Refi. If you questions about any of these options for leveraging your equity, don’t hesitate to reach out to us. We’re here with you every step of the way, from initial curiosity to closing.