Thinking about tackling home renovations? You’re in good company. But have you thought about how you’re going to fund those projects? Tapping into your home equity is a great place to start, and for many homeowners, a HELOC is one of the first options that comes to mind. However, with the movement of today’s housing market, HELOC, or home equity lines of credit, may be harder to come by. Plus, a HELOC not even be your best option when weighing the pros and cons against those of a cash-out refinance.
So, is it better to get a HELOC or refinance your mortgage? Let’s break it down.
What is a HELOC?
To understand whether it’s better to get a HELOC or refinance your mortgage, it’s important to understand just what a HELOC is.
- A HELOC, or a home equity line of credit, is a loan in which the lender agrees to lend a maximum amount within an agreed period, where the collateral is the equity in your house. Think of it like a credit card that’s connected to your home equity rather than your bank account.
- A HELOC is often referred to as a lien on your home, or a second mortgage, because it’s another loan in addition to your first mortgage.
- HELOCs have their merits and are typically considered a secure form of debt, but you’ll see there can be a number of drawbacks to this type of financing depending on your circumstances.
HELOCs: The Drawbacks
So, if a HELOC is just a loan that lets you use your home equity, what could be the potential drawbacks? Well, for starters:
- Getting a HELOC means adding another monthly payment to what may already be a tight budget.
- HELOCs come with adjustable rates, which means payments will fluctuate—sometimes each month. This can make budgeting more challenging and put you at the mercy of the market market.
- You may have to pay different fees throughout the course of a HELOC, like an annual fee or inactivity fee.
- You’re required to pay interest on the money you withdraw. And although HELOCs offer the option of interest-only payments for a period of time, you risk making payments for longer than you need to.
- The interest you pay on HELOCs is only tax deductible* if it’s used to build on or improve the home that secures the loan.
- HELOC lenders only allow you to withdraw money during a predetermined “draw period.” Also, they typically enforce a minimum draw requirement. That means you have to take out the minimum required amount even if it’s more than what you need at the time.
- Since a HELOC is a loan secured by your home, if you’re unable to make payments on your HELOC, you risk losing your home.
While there may be some benefits to HELOCs, the risks can be high—even for lenders. That’s why HELOC lenders are pulling back on offering this type of financing.
So, with fewer lenders offering HELOCs, how do you get cash to renovate your home in the current market?
*This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before making the decision to buy or refinance a home.
HELOC vs. Cash-Out Refinance
Cash-out refinance to the rescue. Here’s what it all boils down to: Why get credit when you can get cash? After all, it’s your hard-earned home equity on the line. That’s why cash-out refis can be a smart solution for homeowners who want to leverage their home equity. Take a look at the benefits.
- With cash-out refinance, you refinance a your mortgage for more than what you currently owe and pocket the difference in cash. It’s one monthly payment—no separate loan!
- A fixed-rate equals predictable payments, making budgeting easier and less stressful.
- All fees for a cash-out refi are collected up front, and interest rates are typically lower than that of HELOCs.
- No draw periods, no minimum draw requirement, and no extra interest-only payments. The only caveat is lenders limit how much cash you can take out to keep you from tapping into 100% of your home equity.
So, is it better to get a HELOC or refinance?
As in all things mortgage, the right choice depends on your goals. Overall, a cash-out refinance tends to be a less risky (and more widely available) way to leverage your equity than a HELOC. Keep in mind that a cash-out refi typically means you’ll have a higher monthly mortgage payment. When it comes to financing home renovations, a cash-out refinance can help you cover those upfront costs like materials and labor all at once. With a HELOC, the limited amount you can draw from your line of credit at a time might not be conducive to paying for home projects.
The bottom line
Figure out your financial goals before you decide if it’s better to get a HELOC or refinance. Luckily, our loan originators are here to help you do just that.
Using your home equity to pay off debts or make other purchases does not eliminate the debt or the cost of the purchases, but rather increases the loan amount of your mortgage to be paid according to your new mortgage terms.
Is it better to get a HELOC or refinance? While there may be some benefits to HELOCs, the risks can be high—even for lenders. A cash-out refi tends to be easier to qualify for.