Numbers Count: Refi or HELOC? Home remodels tick up

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Numbers count. They matter to bankers and to prospective homebuyers, sellers, and real estate professionals. Here’s my take on the key numbers on the housing market this week.

African American man in sweatshirt and goggles as he gets ready to drill into the molding near roof inside his house.The numbers: The National Association of Home Builders’ Remodeling Market Index (RMI) posted a reading of 58 in the fourth quarter, up one point from the third quarter, indicating continued confidence among remodelers.  A reading above 50 means more remodelers report activity has improved than report activity has deteriorated. The amount of work committed and appointments for proposals each rose two points from the previous quarter’s readings—to 57 and 60, respectively, according to the report issued January 15.

What counts: Home remodeling is going strong. Frequently, home remodeling goes hand-in-hand with cash-out refinancing or home equity lines of credit (HELOC). Both forms of borrowing give a homeowner access to cash to pay for remodeling by tapping equity in the home. Each form of borrowing has pros and cons, so let’s look at a few for both.

Home equity line of credit: If you have a first mortgage, you are building equity in your home with your payments over time. A HELOC is additional borrowing secured by your home that allows you to tap into your equity in the property, providing access to cash for home improvements, education expenses, consolidating other debts, or other uses.

  • Rates on HELOCs tend to be lower than rates on credit cards because they are secured by the borrower’s home, so lenders view them as less risky than other types of credit.
  • A HELOC provides flexibility: You can borrow what you need when you need it, and pay down the balance if you have extra cash. On a remodel, for example, you can borrow funds as you need them for the project, rather than borrowing a lump sum and immediately having to pay interest on that full amount.
  • A HELOC typically has an initial “draw period” when you can tap the line of credit, and the monthly payment is interest only. The advantage to this is the monthly payments will be lower. The risk, however, is that when the draw period expires, you may be surprised by a much larger monthly payment if you only paid the minimum interest-only payments during the draw period. That’s because your payments during the repayment period that follows the draw period include both interest and principal.
  • A risk of a HELOC is the interest rate, which is typically adjustable. So if interest rates rise, you may have higher monthly payments.
  • Finally, because a home equity line of credit is secured by your home, your lender has a claim on your home to recover the outstanding balance if you are unable to repay the HELOC.
Cash-out refi: In a cash-out refinancing, you refinance your primary mortgage and increase the size of the mortgage to withdraw cash. Here are some advantages and risks of a cash-out refi:

  • The repayment period is usually long – 30 years or 15 years, if you refi into a 30- or 15-year mortgage. This long repayment period helps keep the monthly mortgage payment relatively low, but could increase or decrease the amount you pay each month, depending on the interest rate you obtain on the refinance product and the amount you borrow.
  • If you choose a fixed-rate mortgage, your payment will be fixed and stable for the life of the loan.
  • With a cash-out refi, you will receive all the cash shortly after closing the loan. The advantage is you have a pile of cash. The disadvantage is you have a pile of cash. You are paying interest on that full amount, and you need to be disciplined to only use it for the intended purpose of the refi (and avoid the temptation to go out for a lobster dinner or take a weekend getaway).

Cash-out refis and HELOCs allow financially responsible homeowners to take advantage of the equity built up in their homes. While there are risks of using your home to secure a loan, both types of financing can provide financial flexibility when managed effectively.

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