Which Is Best for Tapping into Equity: Refinance, Home Equity Loan, or HELOC?

HouseTapping into home equity by is a great way to afford expenses like college tuition or home improvement, and it is a cost-effective way of consolidating debt from credits cards or medical expenses.

There are three options — refinances, home equity loans, and home equity lines of credit (HELOCs). These loans have slightly different terms and conditions that homeowners should review before deciding which one is best for them.

Refinance

A refinance with cash out works as follows: The homeowner takes out a completely new mortgage, adding an additional amount based on the equity in their homes. Lenders will not allow homeowners to refinance a loan that is more than 80% of the home’s appraisal value, so the amount of money one can access through a cash out refinance is limited. However, if the interest rate is much lower at the time of the refinance, and homeowners plan to remain in their home long enough to absorb the closing costs associated with a refinance, this option makes a lot of sense.

 

Home Equity Loans

A home equity loan is a second mortgage. Terms for these loans vary depending on the amount of equity a homeowner has and how good their credit is; depending on the current market, interest rates for a second mortgage may be lower or higher than the primary mortgage loan. A home equity loan with good terms may be good choice, especially if there is no penalty for prepayment so that homeowners have the option to pay down the principle.

Home Equity Line of Credit (HELOC)

HELOCs are lines of credit are variable rate products with the rate generally tied to the Prime rate. When a homeowner takes out a HELOC, he gets a line of credit in an amount pre-determined by the lender based upon the equity in the home and the credit situation of the homeowner. The homeowner is allowed to withdraw funds up to that amount during an initial draw period; the remainder of the loan term is for repayment.

A primary advantage of HELOC loans is one makes interest-only payments during the draw period, and generally there is an excellent introductory rate set by the lender. For homeowners who are able to repay the line of credit in full at the end of the draw period, or for individuals who are planning to move at the end of the draw period, these loans are a great deal.