HELOC vs. Cash-Out Refinance

The mortgage industry has one flaw: There is no built-in way to access equity.

For many home owners who want to use their equity to pay off debt, start a business, invest in the market, or just use the money for purchases, they cannot unless they take out another loan. The two most popular ways to do this is with a home equity line of credit (HELOC) or a cash-out refinance.

A HELOC is a second mortgage secured by your home. A cash-out refinance is a first lien mortgage that “cashes out” some of your equity in your home. Which is better depends on your situation, the market and your goals.

Here are a few factors that might help make the decision easier for you and your family.

1. Take a look at your current interest rate. If your mortgage interest rate is low compared to the current market and you are borrowing a low amount compared to what is owed on your first mortgage, a HELOC maybe you best option. Why? Although the equity line is higher interest, it is only on a relatively low amount and you can keep your low rate on your first mortgage.

If current rates are lower than your first mortgage or if you are borrowing an amount approaching 50 percent of the current amount owed on the mortgage, it may be better to do a cash-out refinance. This is because the equity line interest is generally higher than the current market rate could make your payment higher. Additionally, because the equity line is generally adjustable, there is a risk that volatility will make your payment unpalatable.

2. Analyze payment vs. interest savings vs. risk. If your ultimate goal is to keep your payment as low as possible, an equity line might be a good choice. Remember, the equity lines are usually interest only and therefore the monthly payment stays relatively low. However, there is a risk in them because they are also adjustable.

If you’re goal is to pay your mortgage off as quickly as possible and pay the least amount of interest, a cash-out refinance is often times better. Again, this is because you pay both principal and interest on cash-out refinances and they are fixed rates.

3. Pay attention to costs. If the up-front costs are a determining factor, the equity line is the way to go. HELOCs are generally free, whereas, a cash-out refinance will add principal to your current mortgage.

4. Keeping it all in one loan. Many people do not like the idea of having two different loans. Even if the equity line is with your first mortgage servicer, there will be two different loans with two different payments and two different statements. These will also have different terms and most likely different rates. On a cash-out refinance there will all be one loan, one term and one rate.

When determining whether to do an equity line or the cash-out refinance it is important to determine long term goals, what your current needs are, and which option will put you in a better position in the long run.

Talk to a trusted advisor to help you navigate your best options.