Heloc vs Refinance vs New Mortgage. Which One is Better?

heloc vs refinance

Imagine that you bought a house and started slowly paying off your mortgage, but something went wrong and you really need some cash. Do not worry, today’s have a lot of possibilities for that and it will be much better to choose between heloc vs refinance vs the second mortgage than having a new credit card. Today we will look at these three ways in greater detail, analyze several examples and see the advantages and disadvantages of each way.

Example 1: Tom’s HELOC

Let’s imagine that your good old neighbor Tom bought a new home which costs $300,000 and made a contract for 5-year fixed at 3.50%. Tom pays his interest for the whole already but he still needs to pay $200,000 despite the fact that he made a large down payment and has a good equity build-up in his new home. 

Tom needs money for a bedroom repair. As you can guess it is not cheap at all. Moreover, Tom needs to pay approximately $6,000 as a prepayment penalty to refinance.

Tom read a lot of information on the topic and decided to open HELOC, consequently, he can gain access to:

  1. Home Value x 80% – Outstanding Mortgage = Available Equity
  2. $300,000 x 80% – $200,000 = $40,000

Despite the fact that now Tom needs to make an additional payment for HELOC each month, a home equity line of credit (HELOC) is a good choice for him, because now he has access to a revolving line of credit, which is quite useful because he can borrow as much money as he needs for his renovation program. But what is better heloc vs refinance? Let’s see in the other example.

Example 2: Helen’s Refinance

3 years ago your wife`s friend Helen bought a new apartment which cost $470,000. Her mortgage is a 5-year variable at 5.00% and she already paid $325,000 for these three years. Helena complained to your wife that post-secondary school costs a fortune, but her child still needs it. Her wife recommended Helena refinance her mortgage. 

She thought that it is a great idea because in this case she can improve her mortgage rate and gain a large sum of money. She even was not scared of a one-time prepayment penalty of approximately $3,000 because she gained much more with a less regular mortgage payment.

  1. Home Value x 80% – Outstanding Mortgage = Available Equity
  2. $470,000 x 80% – $325,000 = $51,000

Example 3: John’s Second Mortgage

Despite the fact that John is a great guy he is always in debt. And now again he needs to borrow money to consolidate debt. Lucky for him, he already has paid the mortgage for 2 years and has some equity in his house. The overall cost of his house is $433,000 and he already paid $350,000. His mortgage is 5-year fixed at 3.69% and his debt is $25,000 total on 3 credit cards, all at 19.99%.

  1. Home Value x 90% – Outstanding Mortgage = Second Mortgage
  2. $433,000 x 90% – $350,000 = $39, 700

Now John needs to pay the debt for his first mortgage and for a new one, however, he will save thousands of money on the interest because it became 3,69% instead of 19,99%. His expenses also include paying different fees, however, he will have enough money to pay them and even some money will be left. 

HELOC vs refinance: 3 Ways to Access Equity in Your Home

Above we have analyzed different ways to gain access to your equity accumulated in your home. However, we still have not said which one is better: heloc vs refinance vs the second mortgage, so let’s look at them closer.

  • Home equity line of credit (HELOC)
  • Refinance mortgage
  • Second mortgage

HELOC vs refinance: What HELOC Is?

A HELOC (home equity line of credit) is a revolving line of credit on which you can borrow up to 80% of the value of your home. It is secured by your home and has no fixed interest. The bank advances money on the HELOC but does not charge any interest for this advance. Even if you default on your mortgage payments, you will not be in financial trouble because this new line of credit can never go into arrears.

Advantages of this way are that you can access money only if you need it and pay percent only if you have taken the money. However, there are several disadvantages, to gain HELOC you need to have a high credit score. Moreover, your regular payments will be increased.

HELOC vs refinance What Refinancing Mortgage Is For?

A refinancing mortgage is used to lower your monthly payment on your current mortgage, pay off some of the principal balance on your current first mortgage, or you can use refinancing to get a new loan for improvements to your home. In the first case, there is a risk of you losing money if you go ahead to refinance. In the second case, refinancing can offer you a lower interest rate on a new mortgage.

This type of loan is good for those who want to gain a better interest rate on the existing mortgage and free up equity at the same type. Disadvantages of such a type are that you need to have a good credit score and pay not only interest but also principal debt.

What Second Mortgage Is For?

This type of loan usually has a one-time fee and a higher interest rate. It is usually reserved for financing home improvements or paying off other debts such as credit cards, student loans, and car loans. Second mortgages are used for making improvements to an existing home or borrowing money for a new construction project. Second mortgages are secured by a lien on a property and have higher interest rates than first mortgages.

This case has a big advantage — you do not have to have a high credit score to have it. However, as in other ways you still need to pay a lot of additional fees and your regular payments will be higher than before.

HELOC vs Refinance: Conclusion

In the end, we have to say that each of these ways has its own advantages and disadvantages. If you want to gain a lot of money and free up equity with this action, then a second mortgage can be a good choice. It is not expensive and you do not need a high credit score to get it. Furthermore, you can gain access to a large amount of money without any troubles instantly.

However, you also have to pay a lot of money this way and your regular payments will be higher. In general, there is no good or bad side to the matter. It depends on your goals and needs.

To conclude, a home equity line of credit makes a good choice for those who want to gain access to their equity but still increase their regular payments. However, it’s not a bad choice for those who need a lower interest rate on a new loan or do not have a high credit score.

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