It has been a while since my last mortgage match-up, so without further ado, let’s discuss a new one: “Cash out vs. HELOC vs. home equity loan.”
Yes, this is a three-way battle, unlike the typical two-way duels found in my ongoing series. Let’s discuss these options with the help of a real-life story involving a buddy of mine.
A friend recently told me he was refinancing his first mortgage and taking cash out to complete some minor renovations. I asked how much cash he was getting and he said something like $30, 000.
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Here in Los Angeles, $30, 000 isn’t what I’d call a large amount of cash out. It might be in other parts of the country, or it may not.
Anyway, I asked him if he had considered a HELOC or home equity loan as well. He said he hadn’t, and that his loan officer recommended refinancing his first mortgage and pulling out cash.
For the record, a loan officer will probably always point you towards the cash out refinance (if it makes sense to do so, hopefully).
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Why? Because it works out to a larger commission since it’s based on the full loan amount. We’re talking $530, 000 vs. $30, 000.
Now the reason I bring up the amount of cash out is the fact that it’s not a lot of money to tap while refinancing a near jumbo mortgage.
My buddy could just as well have gone to a bank and asked for a line of credit for $30, 000, or even applied online for a home equity loan of a similar amount.
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The upside to either of these alternatives is that there aren’t many closing costs associated (if any), and you don’t disrupt your first mortgage.
Conversely, a cash out refinance has the typical closing costs found on any other first mortgage, including things like lender fees, origination fee, appraisal, title and escrow, etc.
In other words, the cash out refi can cost several thousand dollars, whereas the home equity line/loan options may only come with a flat fee of a few hundred bucks, or even zero closing costs.
Home Equity Line Of Credit (heloc)
You may also be able to avoid an appraisal if you keep the LTV at/below 80% and the loan amount below some key threshold.
Another advantage to a HELOC or HEL is that you don’t disrupt your first mortgage, which may already have a nice low fixed rate.
It may also be close to paid off, with most payments going toward principal. In that case, you may not want to mess with it late in the game.
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Adding cash out to a first mortgage could also potentially raise the LTV to a point where mortgage insurance would be required; clearly that would be no bueno.
Adding a second mortgage via a HELOC or HEL allows you to tap your equity without touching your first mortgage or raising the LTV (just the CLTV).
Now this potential pro may not actually be an advantage if the mortgage rate on your first mortgage is unfavorable, or simply can be improved via a refinance.
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It turned out that my pal had a 30-year fixed rate somewhere in the 5% range, and was able to get it down under the 4% realm with his cash out refinance, a win-win.
The mortgage was also relatively new, so most payments still went toward interest and resetting the clock wasn’t really an issue. For him, it was a no-brainer to just go ahead and refinance his first mortgage.
When everything was said and done, his monthly payment actually dropped because his new interest rate was that much lower, despite the larger loan amount tied to the cash out.
How A Heloc Works: Tap Your Home Equity For Cash
Keep in mind that it could go the other way. If you take a lot of cash out on your first mortgage, there’s a chance you could raise the LTV to a point where your interest rate goes up.
For the sake of comparison, let’s assume he had a super low rate of 3.25% on a 30-year fixed. He wouldn’t be able to match that rate, let alone beat it.
In this case, he’d maybe be better off going with a HELOC or HEL instead to keep the low rate on his first mortgage intact.
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That relatively low loan amount ($30k) also means it can be paid back fairly quickly, as opposed to say a $100, 000 HELOC or HEL, even if the interest rate is a bit higher.
The downside to a HELOC is that the rate is variable, tied to the prime rate, which was recently raised for the first time in several years and faces future increases as the economy improves and inflation is contained.
Fortunately, the low loan amount means he can pay it off quickly if rates really jump, though chances are they’ll slowly inch up .25% every few months (but who knows with the Fed).
Fixed Rate Home Equity Loan
Additionally, HELOCs use the average daily balance to calculate interest, so any payments made during a given month will make an immediate impact.
This differs from traditional mortgages that are calculated monthly, meaning paying early in the month will do nothing to reduce interest owed.
A HELOC also gives you the option to make interest-only payments, and borrow only what you need on the line you apply for.
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This provides extra flexibility over simply taking out a loan via the cash out refi or HEL, which requires the full lump sum to be borrowed at the outset.
However, if he chose the home equity loan instead, he could lock-in a fixed rate and pay back the loan faster and with less interest.
The HEL option gives him the certainty of a fixed interest rate, a relatively low rate, and options to pay it back very quickly, with terms as short as 60 months.
How To Get A Home Equity Line Of Credit In 2023
For someone who needs money, but doesn’t want to pay a lot of interest (and can pay it back pretty quickly), a HEL could be a good, low-cost choice if they’re happy with their first mortgage.
Every situation is different, but hopefully this story illustrated some of the pros and cons of each option. Here is a list of the potential advantages and disadvantages of each for the sake of simplicity.Home equity loans are secured against value that you’ve built up in your home: meaning your down payment, what you’ve paid toward principal in your monthly mortgage payments and home appreciation. They typically come with lower interest rates than unsecured loans.
You can use home equity loans for anything you like, from home improvements to travel or education costs. We offer two ways to tap your home equity: a fixed-rate loan for a set amount, and a variable rate line of credit.
Suntrust Bank Home Equity Loans Reviews (2023)
This is our standard fixed-rate loan that’s secured by your home. It’s also known as a second mortgage. You borrow a lump sum all at once, and your monthly payment never changes for the life of the loan.
Home equity loans are great if you know exactly how much cash you need. You can use the loan for anything—but if you use it for home improvement, you can deduct the interest from your income tax (please consult your accountant).
A home equity line of credit (HELOC) lets you borrow what you need, when you need it; you only pay interest on the money you withdraw within the first 10 years. These loans are great for ongoing projects. The interest rate varies based on market rates.
New Tax Law & Home Equity Loan Interest Deductions
With our home improvement loan, you can borrow up to 133% of your home’s current value to use toward home improvement, including upgrades to heating systems and adding energy efficiency items such as solar panels or new windows. This is a fixed rate second mortgage with no closing costs.
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*Rates shown are Annual Percentage Rate (APR). HELOC promotional rate of 3.99% APR is fixed for the first 12 months. After the promotional period, the rate will vary based on the Wall Street Journal Prime “Prime” rate published on the last business day of the month, 8.25% APR as of 5/4/23. APR may increase after the loan is closed; maximum APR is 17.125%. Minimum line of credit is $25, 000. Property insurance is required. During the 10-year draw period a Home Equity Line of Credit with a balance of $25, 000 and APR of 3.99% for the first 12 billing cycles will result in 12 interest only payments of $83.13. After the promotional period a balance of $25, 000 and variable APR of 8.25% will result in 108 interest only payments of $171.88, followed by
