With the vast gains in home equity you’ve realized recently, you might ask yourself: “What is the best way to borrow money from my home?” The two most common options would be either cash-out refinance or a home equity line of credit (HELOC).
A cash-out refinance is when you borrow a higher loan amount than your existing loan and use it to pay off the current loan. These are longer-term, fixed loans that would allow for just one payment. The difference between the loan amounts is paid to you as cash. For example, if you owed $300K and borrowed $500K you would receive around $200K as cash back. This was an ideal option when rates were lower. Now that market rates are higher; a new rate would likely be higher than the existing loan.
A HELOC leaves the existing loan in place and adds a second lien to the home. By leaving the first alone, the rate and terms of that loan are not changed. The HELOC is a line of credit secured by the value of your home. The payment is usually interest only for the first 10 years; you can pay it back and reborrow it as needed. Lately, this has become the preferred option. This loan is tied directly to the federal funds rate. When you hear that the Fed is raising interest rates by 0.75%, these loans also go up 0.75%.
Comparing rates and payments directly is not the best consideration. We use the blended rate to evaluate options. The blended rate compares the interest paid on both loans over the combined loan amounts. A $200K first at 3.25%, a second at $120K at 6.375%, and $20K in credit cards at 20% would have a blended rate of 5.34%.
This leads to our first important question: How much do you need to borrow? Chances are that if you are looking to borrow under around $100K, a HELOC would be better. As the HELOC and other debt become a more significant portion of the amount owed (like above), it will likely make more sense to give up your existing loan and do a cash-out loan.
Another critical factor is how long you need the money. A HELOC is best designed for short-term borrowing. Take the amount you want to borrow and divide it by 60 months. If you can pay it back in 2-5 years, you’ll know it is a good option. If you are financing home improvements, you should consider longer-term loans.
Last, you should consider your ability to afford rate increases. Let’s say you borrowed $150,000 on a HELOC when the rate was 4.0%. That same loan is now about 6.5%. That interest-only payment would go from $500 p/mo to $812 p/mo. A longer-term fixed loan is critical if you have a fixed income and can’t ride the rate increases.
Our job is to help you create options and give you all the info so you can make competent decisions. Call us! We’ll help make it simple!