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A couple reviews the similarities and differences between a HELOC vs. a refinance with a financial advisor.

HELOC vs Refinance: Which One Is Better?

Deciding between a HELOC and refinancing is often confusing and leaves little room for error. Interest rates, costs, loan terms, and long-term implications can significantly impact your financial health and future planning.

Understanding the nuances of these home equity loans is essential to make a more informed choice tailored to your needs and goals. Read on to determine if a HELOC or refinancing suits your financial goals best.

What Is a HELOC?

A home equity line of credit (HELOC) allows homeowners to borrow money using the equity they have built up in their home as collateral. Lenders give you a maximum loan amount based on the appraised value of your home minus any outstanding mortgage balances.

You can then draw funds against this line of credit as needed, typically up to a certain percentage of each month’s available limit. HELOCs usually offer variable interest rates, meaning the rate can change over time depending on market conditions.

What Is Refinancing?

Refinancing involves replacing your existing mortgage with a new one that often comes with more favorable terms. When you refinance, you pay off your current mortgage balance with the proceeds from the new loan. 

You then start paying the new loan according to its updated terms, such as a lower interest rate or different repayment schedule. There are two main types of refinancing: rate and term refinancing and cash-out refinancing. 

Rate and term refinancing simply adjusts the interest rate and/or repayment period without tapping into your home’s equity. Cash-out refinancing, however, replaces the old mortgage with a larger loan, allowing you to access some of your home’s equity in cash.

Similarities Between HELOCs and Refinancing

Both HELOCs and refinancing options use your home as collateral. This means a potential risk is involved should you fail to repay your loans. Closing costs are part of both options, but their sizes and structures can differ. Lastly, HELOCs and refinanced mortgages appear on your credit report and can impact your credit score and history.

Side-by-side Comparison: HELOC vs. Refinancing

HELOC

Refinancing

Type of Loan

HELOC

Revolving line of credit

Refinancing

Fixed-rate installment loan

Interest Rates

HELOC

Variable

Refinancing

Fixed or variable (depending on type)

Closing Costs

HELOC

Typically lower

Refinancing

Generally higher

Access to Funds

HELOC

As needed within limits

Refinancing

All at once

Repayment Terms

HELOC

Lower payments during the draw period; principal & interest payments after the draw period ends

Refinancing

Set repayment schedule

Tax Deductibility

HELOC

May be tax deductible for interest paid (consult a tax professional)

Refinancing

Potentially tax deductible (depending on the purpose of funds and type of refinancing)

Tax Implications: Understanding the Differences

Interest deductions can significantly affect the overall cost of borrowing for HELOCs and refinancing. Knowing the differences in tax implications for each option can help you make a more informed decision.

For HELOCs, only the monthly payment’s interest portion is typically tax-deductible (subject to certain limitations). These limits usually depend on the purpose of the loan. For example, the interest paid on a HELOC for home improvement projects may be tax-deductible.

However, the interest used for other purposes (like debt consolidation) may have restrictions regarding tax deductibility. Be sure to consult a tax professional to understand the full extent of any tax benefits related to a HELOC.

Generally speaking, refinancing your mortgage allows the entire interest payment on the new loan to be tax-deductible. As with HELOCs, it’s important to consult a tax expert to ensure you’re taking full advantage of potential tax benefits from refinancing.

Impact on Credit Score: Assessing the Effects

HELOCs and refinanced mortgages impact your credit score, but understanding the specific ways they do so can provide valuable insights as you consider your options.

HELOCs appear on your credit report when you open the line of credit, potentially negatively affecting your credit utilization ratio. This ratio compares your outstanding debts to your available credit across all accounts. 

Opening a HELOC increases your available credit and can positively influence your credit score when managed responsibly. However, using too much credit can potentially lower your score due to increased credit utilization.

Refinancing, on the other hand, has two primary impacts on your credit score. Replacing your existing mortgage with a new one involves closing the old account. This can shorten the length of your credit history and potentially lower your score.

Applying for a new mortgage involves a hard inquiry on your credit report, which can temporarily ding your credit score. Multiple inquiries within a short period might also result in fewer offers of favorable rates and terms from lenders.

Pros and Cons of HELOCs

Like any financial product, HELOCs have advantages and disadvantages that are important to weigh when deciding if this option is right for your needs.

Pros:

  • Offers flexible access to funds as needed
  • Often has lower closing costs than refinancing
  • Can provide a source of emergency funding or debt consolidation

Cons:

  • Variable interest rates expose borrowers to rate fluctuations
  • Requires repayment of principal and interest after the draw period ends
  • Default risks involve foreclosure on your home

Pros and Cons of Refinancing

Refinancing can provide multiple benefits but also has some potential drawbacks to consider before replacing your mortgage with a new one.

Pros:

  • It provides the opportunity to secure a lower interest rate or better repayment terms
  • Cash-out refinancing allows homeowners to tap into their home’s equity
  • Fixed-rate loans offer stability and predictability in monthly payments

Cons:

  • Higher closing costs compared to HELOCs
  • Locking into a fixed interest rate may not be advantageous if rates drop later
  • Extending the repayment term could result in paying more interest over the life of the loan

When to Choose Each Option

Deciding between a HELOC and refinancing depends on your financial goals, current mortgage terms, and personal preferences. Assess your needs, budget, and comfort level with interest rate risk before deciding which path to take. 

For example, if you need flexibility in accessing funds and prefer only paying interest during the initial drawing period, a HELOC may suit you. However, refinancing might be better if you want to lock in a lower interest rate or improve your repayment terms. Consider cash-out refinancing to tap into your home’s equity for a project like home improvements or debt consolidation. 

Remember that it’s always wise to consult with a free financial advisor or mortgage professional when considering major financial decisions like these. They can help weigh the pros and cons in more detail that are specific to your situation and guide you toward the best option.

Which Way of Tapping Into Home Equity Is Right for You?

Choosing between a HELOC and refinancing shapes your financial journey and how you manage your home equity. Each option offers distinct advantages and considerations tailored to diverse needs. 

At NextMark Credit Union, we provide customized home equity solutions that deliver maximum value aligned with your unique financial goals. Click the link below to explore our full range of options and let us guide you to the best decision for accessing your home’s equity.

LEARN MORE ABOUT NEXTMARK HOME EQUITY OPTIONS

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