Cash out refinance or HELOC?

Question

My wife and I are looking into a couple of different options to fund our first rental property. Originally we were looking to do a cash out refi on our house to get money for the down payment on the rental of 25%. Ideally we would need about 50k out of the house for the market that we are looking into. Currently we own 175k on the house and a conservative value would be 270k. With those numbers we would get about 35k but I think the house would appraise for more potentially getting up to 50k. Rates have been quoted between 4.5% and 5.2% with about $3500 in closing costs.

I had one loan officer that was a friend tell me that I should get a heloc instead of refinancing because even with the higher variable rate I will still be saving for the little amount that we are pulling out over the closing costs of a refi.

I also had another loan officer tell me that was a terrible idea because the rates are going to go through the roof and I’m going to pay more in the long run on a heloc that he has one and wished he never got it.

Just looking for some advice as to what will save the most in the long run. We ideally would have the heloc paid off in 5 years.

Ivory Hayes · Answer

I think Shaun Weeks response was very informative, insightful and great advice.

Me myself, I am pro heloc. It can simply be used as your new checking account to pay off the monthly interest payment and to pay down the prinicipal all at the same time without having to come up with any extra money.

What I mean by that is... With the heloc option you and your wife can take all of the money that you earn every two weeks or every month, however often you both get paid, and put it all in to your heloc account. The first 200 (as the example given) will go towards paying off the interest for that month, then the other monies that you both deposited will be a principal payment. It goes directly towards paying down the principal balance. That money sits there, working for you by paying down that principal and it works for you by lowering the principal, therefore lowering your next month's interest payment simply because you now have a lower principal balance on the heloc. This happens every month might I add. Another thing I enjoy about a heloc is, if you need the money again for any reason at all in life, it's there for you to utilize. With a cash out refi you have to go through all of the paperwork again to apply for another loan and pay closing cost fees all over again and start all over from scratch on your 30 year mortgage getting you nowhere close to ever paying off your house and owning this asset. Well, no closing cost fees for you to pay on a heloc with most financial institutions.

If it's sounding a little weird over the text I'd be happy to break it down for you over a phone call if you'd like. Just reach out to me through a pm and we can chat. I'd like to add value to your situation if I can. That's what bp is all about right...

I hope this made sense.

Happy Investing...

P.S.- I forgot to mention... That the draw period is 10 years in most cases meaning you have 10 years to draw from this account and utilize the money any way you choose and you have that long to pay back the 50k with the terms of interest only before the pay back period hits with interest and principal payments, but you can refi the heloc at any point before that, just as you would a loan. Simply do the heloc process over again and your 10 year draw period is renewed where you can pull from your heloc and utilize the money at your discretion with interest only payments.

But the way that I'll show you to utilize your heloc account you're simply leveraging your paycheck to be the monthly interest and principal payment without having to come up with any extra money. The account should come with checks and a bank card so you can also pay all of your bills directly from this account. The interest accumulated on a heloc is based on the daily balance. So the longer your money sits in there without having to be disturbed, the less interest you pay when the bill is constructed.

Once again I hope this made sense. If not, just pm me.

Happy Investing...

Lance Foster · Answer

@Shaun Weekes I get what you’re saying about the heloc and I think the biggest thing our friend was trying to say is that paying the interest even for 5 years then say do a cash out refi on the rental property to pay off the heloc if we had not already would be cheaper than paying for a complete refi. I’m new to this and am hearing completely contradicting things from friends who are in the industry. At this point it almost seems like what friend do I trust most.

I do like the fact that I know what my payments will be with the refi however, there is no unknowns

Sasha Mohammed · Answer

@Lance Foster take what your LO friends say with a grain of salt. you're going to get different opinions from everyone; opinions are like armpits, remember? At the end of the day, run the numbers. When you're talking money, math is math. The difficult part of this is guessing where rates will be down the road, and what your adjustable rate HELOC payment would be once it adjusts (if it adjusts... it probably adjusts).

Disclosure: i also am a loan officer, and i don't really like HELOCS. But I still offer them when they're in my client's best interest.

IF you plan to take out the HELOC now with the intention of refinancing this home later to pay off said HELOC, then i would suggest you just do the cash-out refi. I say this because if you plan to refi the entire debt anyway in 3-5 years, you're just gambling with the interest rates. May as well lock-in low rates now, eat a slightly higher payment (if it is slightly... again, run the numbers). and if you can afford to throw more $ at it on-top of your new payment, you'll just pay it down more quickly.

Waiting to see what the market holds in a few years to move around this $50k could ultimately end up costing you a lot more if the rates jump up by then. they have been moving upward for the last year, year and a half.

For $50k... it's tough to say without knowing your current 1st mortgage balance, rate, or payment. but i would guess that the stability of a cash-out refi would outweigh the benefits of a HELOC in your situation. you can ask your LO to structure the refi with no closing-costs. there are a couple of ways to do that, but i'll let your friend explain those options.

Shaun Weekes · Answer

Keep doing research and while you are keep saving up as well Sir.  Since you're new to all of this I would just keep learning and just make sure financially you can afford whatever action you decide to take.

You can do this, just do it within your means and duplicate your success every time.  Before you know it, you can quit your 9 - 5 and start experiencing financial freedom.  Patience is your best friend!

Shaun Weekes · Answer

So, in this situation you must sit down with your wife and have that honest conversation.  " Hey honey, if we pull out this HELOC can we realistically pay it off in 5 years "

If this answer is yes and you're basing this off conservative numbers, then go for it.  But if you're budget is tight, and those conservative numbers don't work don't do it.  Here is why in my opinion.

After 10 years that pretty $200-dollar payment is going to turn into a $500 or $600 dollar payment because the interest only period will be over.  Many times, people just pay the minimum Interest only payment and call it a day.  Don't do this  unless you know you can afford that $600 hundred-dollar payment.

Pro's:

Doesn't cost you anything to get one with most banks

It's basically a large credit card so when you pay it off you can use it up again for whatever you need

Con's:

Harder to qualify for one

Rates follow the federal funds rate and lately they've been adding .25% very frequently

In 10 years, who knows what rates will be

Banks have been known to take away lines of credit during down markets or during recessions.

I always like to do cash out refi's because you know what your payment will be for 30 years no matter what.  You won't have any surprises and you can show a seller cash to close out the deal.

Now in your situation you're not sure what the value is, and you don't have a huge cushion to sit on.

In conclusion although I think cash outs are easier and faster in my opinion.  A HELOC however, might be better for you out of the 2 options given because they can go over that 80% LTV without MI and an appraisal.  Hopefully they will do a drive by appraisal or an in-house evaluation.  But if you can’t afford that higher payment after 10 years here is a third option.

The third option is to start saving monies and see if you can meet that 50K half way or at least 25% of the way.  This will make your loan smaller and more manageable in the future.  It will also give you more time to do more research on properties, investing etc.

You'll be just fine and I'm sure different opinions will be given to you on BP.  That's why I love this site.  So much knowledge which at the end of the day is power!

I hope this helps and have a great day.

Cash out refinance or HELOC?

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