Many people are struggling to figure out the best way to draw funds from the increased equity in their home.  If they refinanced a year or two ago, they do not want to lose their low interest rate.  So, many are choosing to obtain a home equity line of credit (known as a heloc).  However, they are surprised when they see the heloc rate.  So, what is the best option?  Do you refinance and lose your rate, or get a heloc?

One factor to consider is the effective rate of the two loans.  The effective rate is a weighted calculation of the interest rate of the first mortgage, and the interest rate of the second mortgage.  Let’s look at an example.

Suppose you have a $100,000 first mortgage at 2.75% and want to draw $200,000 out of your home for repairs, paying down debt, or making a down payment on another property.  You are quoted a heloc rate of prime + 2.0%.  Today’s prime rate is 8%, so, the line of credit rate would be 10%.  Assume today’s cash-out refinance rate is 7% on a 30-year fixed mortgage.  What is the better option, to refinance into a new 30-year fixed mortgage, or apply for the heloc?

Let’s consider the effective rate of these loans.  Below is the calculation:

• 75% x $100,000/$300,000 = 0.9%
• 10% x $200,000/$300,000 = 6.7%

The effective rate is the total, which is 7.6%.  So, in this case, the effective interest rate of the two loans is higher than the 30-year cash out rate.

The effective rate is one factor to consider.  Other factors are the time remaining on your first mortgage, the monthly payments of the two loans, and whether the prime rate will go up or down.  To dive deep into this question, give us a call.  We are professionals and can help you decide the best way to draw equity out of your home.