The material presented here is for educational purposes only, and is not intended to be used as financial, investment, or legal advice.
Smart Borrowing: Home Equity Loan vs. HELOC vs. Refi
If you’re looking for ways to get cash for bills, home renovations or other expenses, your home equity could provide a solution. There’s more than one way to tap into your equity, though. We’re breaking down the pros and cons of a home equity loan vs. a HELOC vs. refinancing.
Home values in Arizona have remained high and interest rates have hovered near historic lows in recent years, causing many homeowners to consider borrowing against their home’s equity. What is equity? The difference between the value of your home and the amount you still owe on your mortgage.
For example, if your home is currently valued at $350,000 based on a home appraisal and you have a $175,000 balance remaining on your mortgage, you would have approximately $175,000 in equity. You may be able to borrow against your equity if you need funds for repairs, remodeling, bills or other expenses. While lenders won’t typically loan you the full value of your home’s equity, they may loan up to 80% of it.
Here are three ways that you can tap into your home’s equity to get cash:
- With a home equity loan
- With a HELOC (Home Equity Line of Credit)
- By refinancing your mortgage with a cash-out option
Home Equity Loan: The Straightforward Choice
A home equity loan uses the equity in your home as collateral. Typically, the lender will arrange for a home appraisal to value your home. With a home equity loan, you would borrow a set amount at a fixed interest rate and pay it back in equal monthly installments – much like you do with an auto loan.
Some of the main benefits of a home equity loan are:
- Your interest rate will not fluctuate
- You know exactly how much you’ll pay each month
- Upfront payment to you of the entire loan amount
HELOC: Flexibility & Options
A HELOC, or home equity line of credit, also borrows against the equity you have in your home. Here’s how it works: First, you are approved for a HELOC amount, which is like your credit limit on a credit card. You may withdraw some or all of your HELOC funds as you need them during your draw period (typically, 5 to 10 years).
Example: Let’s imagine that you are approved for a $35,000 HELOC. You withdraw $5,000 from your HELOC to pay some urgent bills. Five months later, you withdraw $10,000 to pay for a bathroom remodel. At this point, you have used a total of $15,000 of your HELOC funds, leaving $20,000 still available.
So, if you take out money several times during your draw period, your monthly payment is based on the outstanding balance on your HELOC. HELOCs typically have variable rates, which means your interest rate will fluctuate up and down with the market.
Lenders such as Desert Financial offer a fixed-rate HELOC option which allows you to cement your interest rate when you withdraw funds. So, your $5,000 withdrawal at 3.50% will always have that interest rate. However, as you withdraw additional amounts – like the $10,000 to pay for your new bathroom – those amounts will have their own fixed interest rate.
To sum up, benefits of a HELOC include:
- Flexible and easy-to-use
- Withdraw funds only as you need them
- Fixed-rate option available to help you plan your payments
This type of loan works well for situations where you may need the money in smaller increments over time — for example, if you’re planning to complete several remodeling projects in the coming years.
Refinancing: One Loan for Everything
The third option for tapping into your home equity is refinancing your mortgage with a cash-out option. In this scenario, you are replacing your current home loan with a new home loan for a larger amount than what you owe. Let’s return to our $350,000 home example, where your current mortgage balance is $175,000. You work with your lender to get $50,000 cash out with a mortgage refinance. So, your new mortgage amount would be $225,000 — your $175,000 balance plus the $50,000 cash you are borrowing.
Your new mortgage may have a fixed or variable interest rate. The upside of a fixed rate is that your payment amount will be the same every month, making it easy to plan for. However, if interest rates go down to 3% and your fixed-rate mortgage is at 4.5%, you wouldn’t automatically get the lower rate. With a variable rate, you’ll be able to take advantage of low points in the market; however, you would also have your rate rise with increases in the market.
How Each Loan Stacks Up
Now that you understand the basics of each loan type, let’s look at how a home equity loan, HELOC and refi stack up when it comes to costs and benefits. Keep in mind that not every lender offers all three loan types, and each lender will have different terms and options available for tapping into your home’s equity. Check with your credit union or mortgage lender for specifics on home equity options.
|Home Equity Loan||HELOC||Mortgage Refinance|
|Interest rate||Typically fixed||Variable or Fixed-Rate Option||Typically fixed|
|Replaces your current mortgage||No||No||Yes|
|May extend your mortgage term||No||No||Yes|
|Lump sum payment||Yes||No||Yes|
|Flexible if you need more cash||No||Yes||No|
|Repayment term||Typically 10-20 years||Typically 10-20 years||Up to 30 years|
|Closing costs||May be waived by lender||May be waived by lender||Yes|
|Down payment required||No||No||Potentially|
|Interest is tax-deductible||Yes, if money is used to make repairs or improvements to the home/td>||Yes, if money is used to make repairs or improvements to the home||Yes|
Bringing it Home
Ultimately, there are pros and cons to each home equity product. A standard fixed-rate home equity loan might be ideal for a one-time need while rates are low, while a cash-out refinance works best if you want to stick with a single loan payment. A home equity line of credit from Desert Financial offers the most flexibility, especially if you want a low intro rate and the ability to borrow money as you need it. Get in touch with us to talk about your options for home equity and mortgage refinancing!