Given equal numbers, would HELOC vs Cash Out Refi be the same?

Question

So, here's what I mean:

For simplicity sake, lets say both a HELOC and Cash-Out Refi have the same rate and I'm ignoring any closing costs.  If I paid the same amount of money in the same amount of time, would either option basically be the same?

So in other words, given these two scenarios:

• 1. 50k Cash Out Refi.  Pay off the 50k principal in 5 years.
• 2. 50k HELOC.  Pay off the 50k principal in 5 years.

Do I end up paying the same amount of interests for both?  Or do I some how end up paying more with #1 because it's a longer term loan?  I imagine if I'm paying off the principal from #1, that it's lowering the interests paid and is essentially "removing" the 50k from the loan as if it was never there.

My reasoning is that I want to go with #1 so that I have the option to pay slower if need be.  #2 would force me to pay it off ASAP, especially given the variable rate after the introductory period.

Hope this makes sense!  Thanks for the help.

Charlie Fitzgerald · Answer

If you are retiring either of these in 60 months, the initial terms mean nothing.  You are changing them by accelerating the pay-off.  Given the same rates at start and disregarding closing costs, they are essentially the same loan - a 5 year note amortized over 5 years...unless you DO NOT stick to your plan to retire the loan in 60 months.  If you have ANY inclination that this may turn out to be the case, then I would always suggest a fixed rate loan that is fully amortizing vs a variable rate loan that is interest only for any hold period longer than 48 months.

J. Martin · Answer

If you assume everything is exactly is the same, YES, I believe it should be the same.

In reality, the HELOC is going to have WAY lower closing costs in most cases. HELOCs are almost always variable rate, and sometimes have teaser rates, so as you noted, the rate will not be the same either way. Generally, variable rates are about .50-1.00% lower than fixed rate loans, depending on the circumstances.. So the rate should also be lower to start. In addition, the term are more flexible, typically interest-only for the first 10 years, just in case you want/need to reduce payments.

For a short period like 5 years, it's hard to imagine the HELOC being more costly than the cash-out refi, except that it is a low HELOC balance (at least out in my area), and they may charge you extra on the rate.

When you say that you have the option to pay slower with the cash-out refi, I believe you are incorrect. The HELOC typically is interest-only for the first 10 years, rather than amortizing from the beginning on the cash-out refi. So your minimum payment will be significantly higher on the cash-out refi than the HELOC (look up "loan constant" on the internet). In addition, the variable rate will typically be lower to start. The rate will typically only go higher than the fixed rate after several interest rate hikes by the Fed. So your thoughts on having a smaller minimum payment are opposite. HELOC will almost always have lower initial payment.

Good luck!

David L. · Answer

Thanks, JM.

I'm not so much worried about the minimum payment but rather the impending pressure of a higher rate.  From the offers I was looking at locally, after the first 2 years at 2%, it balloons up to about 5%.  And from there it varies based on the rate of WSJ + 1.5%.  I'm definitely new to HELOCs but that is how I understood it.  Could be very wrong.  While a HELOC starts off low, it jumps back higher.  I feel like that offsets the savings of the first 2 years.  Whereas I could refi and get a fixed rate of 3.625%.

Good point about paying interest only at first - did not realize / think of that.  I'll have to check with the lender what their interest only period might be.  That could possibly be the saving grace and give me the flexibility I need.

Charlie Fitzgerald · Answer

My Pleasure @David L.

Andreas W. · Answer

@David L.

For a Heloc 5% interest post teaser period sounds high to me. I am pretty confident that calling other banks will lead you to better terms. Another benefit of a Heloc is that you will participate when rates are falling.

David L. · Answer

Thanks, Charlie.

There is definitely an inclination of possibly not following the 5 years.  Simply because I don't want to tie myself up paying off a loan for the next 5 years and would like to continue investing in other opportunities.  I think the plan would be maybe to interrupt the payment at year 2 and 4 to invest in something else.

Thanks for that wisdom!

Christine T. · Answer

You could use the HELOC to borrow from more than once.  I understand that's not your plan right now but things could change in the future and it's be nice to have that option.

Given equal numbers, would HELOC vs Cash Out Refi be the same?

Most Popular Reply