HELOC Or Cash-Out Refinance: Which Reprices Everything

A lender once described home equity to me as your money, just sitting there. I liked that sentence for about a year, until I worked out what is actually happening when you borrow against a house.

You are not withdrawing your money. You are borrowing somebody else's and putting the house up to get it.

Everything below that is mechanics.

Two ways to do it

A cash-out refinance replaces your existing mortgage with a larger one and hands you the difference. Owe $250,000, refinance into $310,000, walk away with $60,000 and a single loan.

A home equity line of credit, a HELOC, leaves your mortgage untouched and adds a second loan on top of it, structured like a credit card. An approved limit, a draw period when you take what you need, and a repayment period afterwards when you pay it back.

What each one costs

Say the house is worth $400,000 and you owe $250,000 at 5.5 per cent, which is $1,419.47 a month. You want $60,000.

The cash-out column contains the number people miss. It does not cost you 6.75 per cent on $60,000. It costs you 6.75 per cent on $310,000, because the entire loan is repriced and your comfortable 5.5 per cent mortgage stops existing.

Which is why the payment rises by $591.18 rather than the $389.16 that $60,000 at 6.75 per cent over thirty years would cost on its own. The extra $202.02 a month is the price of giving up the old rate on money you were not borrowing.

The risk, in one sentence

If you stop paying either of these, the lender can foreclose on the house you live in.

Sit with that for a moment, particularly if the reason you are borrowing is to clear credit card debt. Card debt is unsecured, and nobody can take your home over a card balance. Move it onto a HELOC at a lower rate and you have genuinely lowered the interest and genuinely raised the stakes.

Sometimes that is still the right call. It should never be an accident.

The variable rate, and the exercise

A HELOC rate is usually variable, tied to an index plus a margin, which means it moves without asking you first. So do this before you sign anything.

Write down what you intend to draw. Multiply it by double your quoted rate. Divide by twelve.

On $60,000 at 8.5 per cent the interest is $425 a month. At 17 per cent it is $850.

Read that second number out loud and decide whether it is survivable. If it is not, borrow less or take the fixed option, and do not let anybody tell you rates cannot move that far, because plenty of people found out otherwise between 2021 and 2023.

There is a second jump waiting even if rates never move at all. Most HELOCs let you pay interest only through the draw period and then switch to principal and interest for the repayment period.

On $60,000 over twenty years that takes the payment from $425 to $520.69, and on a ten year repayment period it is $743.91. Ask how long your repayment period is, in years.

Four questions before you borrow

• What is the money for, and does it leave anything behind? A roof and a kitchen behave differently from a wedding and a holiday, not morally, but in terms of what exists in year eight while the loan is still outstanding.
• What is the total interest across the life of each option, rather than the monthly difference? A refinance that adds $591.18 a month for 360 months is not a $60,000 loan.
• What happens to this debt if you need to move? A HELOC gets settled out of the sale proceeds and quietly shrinks the deposit on your next house.
• Is there an unsecured option at a rate close enough to be worth the safety? Sometimes there is not, and it takes ten minutes to find out.

The thing to do today

Take whatever you are thinking of drawing, double the rate you have been quoted, and write the monthly interest on a piece of paper you will see again tomorrow.

It is a small and slightly theatrical exercise, and it is the only part of this decision that tests the thing that actually goes wrong. If the doubled number is fine, you have a real option and a cheap one. If it is not, you have learned something about the size of the problem you were trying to solve, which is usually worth more than the loan.

The third option, which nobody leads with

There is a product sitting between the two columns. A home equity loan, sometimes called a second mortgage, hands you the $60,000 as a lump sum at a fixed rate over a fixed term and leaves your first mortgage exactly where it is.

So the 5.5 per cent on the $250,000 survives, the new rate cannot move, and the loan amortises to zero on a date you know at the start. The rate usually sits above a cash-out refinance and below a HELOC, with closing costs somewhere in between.

It is the right answer more often than it gets offered, because a lump sum is fixed and a line of credit can be drawn again, and one of those is better for the lender. If you know the number you need and it is not going to change, ask for this quote alongside the other two.

How much they will actually let you take

Lenders cap total borrowing against a house as a share of its value, commonly somewhere around 80 to 85 per cent across every loan on the property. On a $400,000 house at 85 per cent that is $340,000 of room, less the $250,000 you already owe, so about $90,000.

Two things move that ceiling and neither is yours to control. The appraisal, which is somebody else's opinion of what the house is worth and is frequently lower than yours. And the lender's own limits, which tighten when the market does, which is exactly when people want the money.