In this economy, most American homeowners are flush with equity. Having plentiful equity in your home is beneficial for many reasons. It can be a great tool for reaching multiple financial goals, whether you’re trying to pay off debt, lower the principal balance on your mortgage, or buy rental real estate.
If you’re considering using your home equity to grow your real estate portfolio, your options include taking out a home equity line of credit or a cash-out refinance. But how do you decide between the HELOC and the cash-out refinance? On this episode of Investing in Real Estate, we’re going to unpack both of these options.
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Let’s start with the Home Equity Line of Credit
A HELOC is a revolving line of credit, meaning it works similarly to a credit card. It uses a variable interest rate, which is unlike many other banking products. The terms of a HELOC are typically going to give you access to around 80% of your equity. Additionally, there is what’s called a “draw period” where you can access funds. During the draw period, typically you’re only going to be making payments on interest. Then once the determined draw period is over, the credit line goes into full repayment with monthly payments made on both the principal and interest.
Cash-Out Refinance
A cash-out refi is when an existing mortgage is refinanced. When you get a cash-out refinance, you’re essentially getting a brand new mortgage for a higher amount than the initial loan.. The original loan is then paid off, and the difference between the original loan amount and the new loan is what you keep in cash.
In today’s economy, the HELOC comes out on top as the best way to access your home equity. Here are a few reasons why, in my opinion, the HELOC is a better tool than the cash-out refinance.
- Rates. Some people are hesitant about the variable rates that HELOCs offer. According to Bankrate, current rates are hovering around the 8% mark. However, it’s important to remember that this number is an average. Some lenders may allow you to lock in lower rates. You also may be able to find introductory rates.
- Overall price. When you take out a HELOC, you can take out a loan amount of exactly what you need. A cash-out refinance, however, essentially buys you an entirely new mortgage at today’s rate. If your existing home loan is locked in at a decent rate, it likely would not make sense to entertain a cash-out refinance. A HELOC, though, is going to give you a second payment in addition to your mortgage. Unless you’re taking out a very sizeable loan, the numbers will probably favor the HELOC.
- Repeatability. One of the major benefits to the HELOC is that it’s a revolving line of credit, similar to a credit card. If you’re intentional, you can get a lot of bang for your buck while using a HELOC to reach your goals. The HELOC is a great option for an investor who wants to rinse and repeat.
- Shorter timeline. In comparison with a 30-year mortgage, a HELOC repayment period is usually in the 10-20 year range.
For investors though, there’s one big drawback. It can be difficult to find a HELOC on a rental property. But just because it’s hard, doesn’t mean it’s impossible. There are a lot of great lenders out there looking to do deals. It’s just going to take some tenacity on your end.
I hope this info gave you some insight into the world of equity products and how to use them to reach your financial goals. However, if you still have lingering questions about how equity works or how you can use your equity to reach your financial goals, check out this next video: The Ultimate Guide to Leveraging Your Home Equity to Invest.
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FAQs
Since a cash-out refinance is considered a first mortgage, it comes with more attractive rates and less in-depth requirements for approval. HELOCs typically take the form of a second mortgage and are considered riskier. They have variable interest rates, which means you may pay more over the lifetime of the loan.
Is it worth refinancing a HELOC? ›
In addition, if your income or credit score has improved substantially since you initiated the HELOC, it may also make sense to refinance in order to secure a lower interest rate. However, if the balance on your HELOC is nearly paid off, it may not be worth the expense and paperwork to refinance.
Can I have a HELOC and refinance at the same time? ›
If you get a mortgage refinance and HELOC at the same time, the borrower's primary qualification is their ability to maintain a certain debt-to-income ratio. Your DTI should not exceed 28%. Lenders will review your ratio, particularly since you're taking out two separate loans for a home.
What happens to my HELOC when I refinance? ›
You receive the difference in cash and can use some or all of the capital you receive to pay off the balance on your HELOC. In essence, this means that you roll your HELOC into the cost of your new mortgage, where you'll only be responsible for making one monthly payment.
What is the downside of a cash-out refinance? ›
Cash-out refinance cons
You owe more: Because you're taking out a larger loan amount, your overall debt load increases. No matter how close you were to paying off your original mortgage, the cash-out raises your debt level.
Is there a better option than a HELOC? ›
If you know exactly how much you need to borrow, a home equity loan can be a better option than a HELOC. Home equity loans tend to have lower interest rates than HELOCS, and the rates are usually fixed for the life of your loan.
Is a HELOC a bad idea right now? ›
While home-loan interest rates overall have risen dramatically since 2022, HELOC rates still tend to be lower than those on credit cards and personal loans. If you qualify for the best rates, a HELOC can be a less expensive way to consolidate debt or finance a home renovation.
What are the pitfalls of a HELOC? ›
Here are some potential drawbacks to consider before taking out a HELOC.
- Often Variable Interest Rates. Generally, HELOCs have variable interest rates, meaning the interest rate can fluctuate based on market conditions. ...
- Risk of Overborrowing. ...
- Potential for Losing Your Home. ...
- Closing Costs and Fees.
In this regard, your HELOC has a lot in common with a credit card. It can have a small impact on your credit score when you apply for one, but a larger one if payments are late or missed. As additional debt, it can ding it — but can also boost it as an enhancement of your total available credit.
Can I roll my HELOC into my mortgage without? ›
Yes, a HELOC (Home Equity Line Of Credit) can be used as either a 1st or 2nd mortgage. If you already have a first mortgage, you can use a HELOC to tap into your home's equity as long as you have enough equity.
Borrowers often wonder if they can pay off their home equity line of credit (HELOC) early. The short answer? A resounding yes, because doing so has many benefits. If you're making regular payments on your HELOC, you may be able to pay off your debt sooner, so you're paying less interest over the life of the loan.
Will HELOC rates go down in 2024? ›
HELOCs benefit most from rate decreases. With the Fed looking to lower rates later in 2024, a HELOC may be more beneficial than a home equity loan because the rate could go down.
Why use a HELOC instead of refinance? ›
A HELOC is often better than a cash-out refinance when your existing mortgage has a low rate that you don't want to replace. A HELOC lets you borrow only what you need from your equity; and since it's a credit line, if you don't use it, you don't have to repay it.
What do you lose when you refinance? ›
You don't have to lose any equity when you refinance, but there's a chance that it could happen. For example, if you take cash out of your home when you refinance your mortgage or use your equity to pay closing costs, your total home equity will decline by the amount of money you borrow.
Can you lose your home over a HELOC? ›
If you fail to repay your HELOC, your lender may foreclose on your home and you could end up losing it to the bank. In addition, you will have a negative hit to your credit score, making future borrowing more costly or difficult.
How is a $50,000 home equity loan different from a $50,000 home equity line of credit? ›
The line-of-credit arrangement also means you'll only pay interest on the amount you borrow, at least initially. With a home equity loan, you'll be responsible for interest on the entire loan balance, even if you don't use all the funds.
Should I use HELOC or cash? ›
If you intend to use the cash over a period of time, a HELOC may be your best option. This option allows you to withdraw the cash as and when you need it or not use it at all. A HELOC is often used as a backup strategy for example if you lose your job. If you don't use the money, you don't pay interest.
Does a HELOC require an appraisal? ›
Yes, typically an appraisal is required in order to obtain a HELOC, however it is often a less detailed appraisal than necessary for a primary mortgage. To assess the amount of loan a homeowner can be awarded, lenders will need an accurate account of the value and condition of the property.
How much equity can I borrow with a cash-out refinance? ›
Generally, the amount you can borrow with a cash-out refinance is capped at 80% of your home value. However, this can vary depending on the lender and loan type you choose.
