With interest rates at twice what most Americans currently have on their home loan after refinancing over the last few years, those looking to use their home equity when needed are in a bit of a pickle.
Refinancing to take cash out would mean doubling their current mortgage rate. Yet, there are pressing needs of the homeowner, and they may not have the cash or other resources to handle that need; what is a homeowner to do? This short guide will help you with some of the basics to consider regarding when to HELOC and when to refi.
What Is a Home Equity Line of Credit (HELOC)?
Home Equity Lines of Credit, or HELOCs, are loans that allow homeowners to access the equity in their homes as a line of credit. You can use a HELOC to take out a lump sum of cash, or just have it as an open line to access as needed or a bit of both!
A Home Equity Line of Credit (HELOC) can be a smart solution if you have ongoing financial needs and want to access funds at a low interest rate. With a HELOC, you can tap into your home’s equity through the credit line. What is great about a HELOC is that you have a couple of payment options. You can pay only the interest on the amount you use during the first few years, which makes it very affordable, or you can make the fully amortized payment, so you are paying down your principal.
For homeowners who need funds for important expenses such as home renovation, education, or property investment, a HELOC provides a fast way to access equity from their home at a very low monthly payment.
When Is It a Good Idea to Use HELOCs?
First and foremost, you should use a HELOC when it makes financial sense. Then, you need to compare all the elements of both options and decide what is best for you.
Considering that if you have recently refinanced and have a mortgage rate of less than 4%, refinancing and getting a rate of 6% or more right now, which is 50% higher or more, may not make sense.
If you need money to take care of certain needs, a HELOC would be a good option. Here are some cases where you may opt for a HELOC rather than a full refinance.
Home improvement projects
Home improvement projects are one of the most common reasons homeowners opt for a HELOC. Whether it’s a kitchen renovation, a bathroom remodel, or an addition to your home, a HELOC can provide the funds you need to complete the project. With a HELOC, you can finance your project over time as you need the funds instead of paying for everything upfront.
Another popular reason for using a HELOC is debt consolidation. For example, suppose you have high-interest credit card debt or other outstanding loans. In that case, a HELOC can provide a way to pay off those debts and consolidate your payments into one manageable monthly payment at a lower interest rate.
A HELOC can also serve as a source of emergency funds. For example, suppose you need money for an unexpected expense, such as a medical emergency or car repair. In that case, you can access your credit line quickly without going through a lengthy loan application process.
Finally, some homeowners use a HELOC to take advantage of investment opportunities. Whether buying a rental property, investing in cryptocurrencies, investing in stocks, or starting a small business, a HELOC can provide the funds you need to pursue your investment goals.
However, it’s important to consider the risks associated with any investment and to consult a financial advisor before making any investment decisions.
Refinancing and Taking Cash out vs. Getting a HELOC
Comparison between the two options
Refinancing and taking cash out and getting a HELOC are two options for accessing the equity in your home. When you refinance your house, you pay off your existing mortgage and replace it with a new mortgage. On the other hand, a HELOC on the other hand, is a line of credit that lets you borrow against your home’s equity as needed.
Advantages of refinancing and taking cash out
Refinancing and taking cash out have several advantages, including:
- Lowering your monthly mortgage payment if your current rate is higher.
- Converting adjustable-rate mortgage to a fixed-rate mortgage.
- Paying off high-interest debt.
- Receiving a lump sum of cash for a large expense.
- You end up with just one fixed payment.
Advantages of getting a HELOC
Getting a HELOC has its own advantages, including:
- Flexibility to borrow only what you need when you need it.
- Lower interest rates compared to credit cards and other forms of debt.
- Much lower or no closing costs or fees are associated with obtaining a HELOC.
- Ability to pay interest only on the amount you borrow instead of paying interest on the entire loan amount.
When refinancing and taking cash out is a better option
Refinancing and taking cash out is a better option if:
- You have a large expense that requires a lump sum of cash, and it makes sense.
- You have a high-interest rate on your current mortgage and other consumer debt that you want to pay off quickly.
- You want to lower your monthly mortgage payment.
- You have an adjustable-rate mortgage and want to convert to a fixed-rate mortgage.
- You want to extend the amortization and payoff length of your current mortgage to lower your monthly payments (go from a 15-year to a 30-year mortgage).
When a HELOC is a better option
A HELOC is a better option if:
- You have ongoing expenses that require access to funds over time instead of a large one-time lump sum.
- You want the flexibility to borrow only what you need when you need it.
- You want to pay interest only on the amount you borrow instead of paying interest on the entire loan amount.
- You want to access funds quickly and easily without going through the refinancing process.
It’s important to consider the pros and cons of each option and consult a financial advisor before making a decision. Your financial advisor can help you determine which option is best for your specific financial situation.
Considerations before Getting a HELOC
Qualifying for a HELOC
Before getting a HELOC, it’s important to make sure you are a good candidate for it. The requirements for qualifying for a HELOC may vary depending on the lender, but in general, you must have equity in your home and a good credit score. Lenders may also require proof of income, employment, and other financial information.
Qualifying for a HELOC is a bit tougher than doing a refinance because the line of credit is a subordinate lien to the first mortgage. Being in 2nd position is much riskier for the lender, so they want much better credit and more equity than a first mortgage.
The impact of interest rates
HELOCs typically have a variable interest rate that can change over time, which means your monthly payments could increase or decrease based on changes in the interest rate. Before getting a HELOC, consider how changes in interest rates could impact your monthly payments and your ability to repay the credit line.
The length of the repayment period
A HELOC has two components that are unique and different from a fixed 2nd mortgage or your typical fixed-rate first mortgage.
HELOCs have a “draw period” and a “repayment period.” The “draw period” is the first ten years usually, and it’s basically when you can access the line of credit to get your cash. Once that is up, you enter the “repayment period,” which is usually 10 to 20 years. During the repayment period, you are no longer given the option to pay the interest only; it has to be fully amortized to pay off during the year of the repayment period.
Consider how the length of the repayment period will impact your monthly payments and your ability to repay the credit line.
The impact on your credit score
Getting a HELOC can have an impact on your credit score, both positive and negative. A positive impact may occur if you use the credit line responsibly, pay your bills on time, and keep your balances low. A negative impact may occur if you miss payments, have high balances, or use the credit line to finance large expenses that you can’t afford to repay. Before getting a HELOC, consider how it will impact your credit score and plan accordingly.
In conclusion, getting a HELOC can be a great financing option for homeowners who have equity in their homes and a good credit score. Those who want or need to take cash out but don’t want to raise the rate on the mortgage they have now.
However, it’s important to consider all of the factors involved before making a decision, such as qualifying for a HELOC, the impact of interest rates, the length of the repayment period, and the impact on your credit score.