Is a Refinance or Home Equity Line of Credit Better?

Due to the financial concerns caused by the COVID pandemic, many home owners are looking for ways to cut back on the cost of their mortgage. The number of loan refinance, HELOC, forbearance, home equity loan, etc. applications has risen significantly since March.

What if you are interested in possibly making your mortgage more affordable, but don’t know which direction is best for you to take? Most people are looking to refinance, but what if a home equity loan would be the better choice?

Let’s take a look at both refinancing and home equity loans. What are they? How are they different? Which One is Best?

Refinancing

There are two more commonly used types of refinance loans: rate and term refinance and a cash-out loan. Rate and term refinance loans do not involve any money changing hands outside of the closing costs and the new loan holder paying off the old loan. A cash-out refinance turns a portion of your equity into cash in your hands. The buyer ends up with a brand new different mortgage and a check to be cashed.

More: Do You Have to Have Great Credit to Refinance?

Home Equity Loans

A home equity loan gives the borrower cash in exchange for the equity built up on the property. Home equity loans usually offer a lower interest rate because they are secured in the collateral of your equity. The risk here is that the lender can come after your home if you default. Home equity loans are often referred to as a second mortgage. When you take out a home equity loan you do not pay off your first initial mortgage loan. The home equity loan is a second loan you hold on your home so you pay this loan in addition to your original mortgage loan.

Read More: Pros and Cons to a HELOC

Which Loan is Best?

To determine which type of loan might be best for you let’s use a specific home loan situation. Pretend that you purchased a home 10 years ago and the interest rate locked into the 30 year loan was a solid 5%. Today you can qualify for an interest rate of 3.5% and this new rate could lower your monthly mortgage payment by hundreds of dollars. In addition you can also save in the total dollar amount of interest you pay out over the entire life of the loan.

Additional: 4 Smart Moves for Your Tax Return or Stimulus Check

It will cost a little bit of money to pay the closing costs to have everything finalized, but over a couple of years you will hit your break even point. The break-even point is the amount of time it takes to recoup the closing costs in what you are saving in loan payments. This usually takes anywhere from one to five years. So if you plan to live in the home for longer than that period of time, you will be saving money.

Related: What if you need a Jumbo Loan?

"Maybe your current mortgage is at a low interest, just barely above the interest rate you could qualify for now. Right now during the pandemic you could use some extra money to help you with emergency expenses while your hours at work have been cut back or you are unemployed. A home equity loan may be a better choice in this situation." - Kris Swierz, Kirkland Condo Agent

Both types of loans have their own separate pros and cons. One type of loan may be better for one person than the other, it is solely dependent upon your particular personal financial situation. Or you may find that staying put with your mortgage is the best way to go.