Homeowner Headache: Refi or Equity Loan?

A big expense looms over you like college tuition, a new car or major home-improvement. You’re short of cash but do have plenty of equity in your home. What’s the best way to get it: refinance the mortgage or take out a home equity loan or line of credit?

In today’s market the home equity line of credit, or HELOC, offers the lowest interest rate, at least at the start. Many begin below 4%, then adjust to 5% or 6% a few months later.

The standard 30-year fixed-rate mortgage averages about 5.2%, and home equity installment loans with three- to 15-year terms charge from 8.3% to nearly 8.8%, according to BankingMyWay.com.

But choosing the best option involves a good deal more than finding the lowest interest rate.

Of course, for any of these moves to work, you must have equity in your home, which means it is worth more than you owe on your present mortgage. To qualify for a new loan you’ll have to show a solid payment record on the old one and a good credit rating.

Then consider the pros and cons of each type of loan.

Cash-out refinancing

This means taking out a new mortgage that is larger than the balance remaining on the old one, so you can pay off the old loan and use the surplus for other expenses.

Spreading the repayment over 30 years can leave you with smaller payments on the extra cash than if you borrowed the same amount with either type of home equity loan, as they generally have much shorter terms. But stretching the payments over more years means paying a lot of interest.

The biggest drawback of a full refinancing is closing costs, which can come to thousands of dollars.

Refinancing to pull cash out of your home may make sense only if you also benefit by getting a lower interest rate than you’re paying on the old mortgage. Use the shopping tool to find better-than-average deals, such as the 5% rate charged by TD Bank (Stock Quote: TD). With the Refinance Interest Savings Calculator you can compare the old and new loans.