Should I Refinance or Get a HELOC For Home Improvements?

For homeowners who are interested in making certain property improvements without dipping into their savings/investment accounts, you can either opt for a (HELOC) – Home Equity Line of Credit or a refinance.

Things to Consider

When you are deciding which option to choose, you should know what the differences are:

  • Timeline- This is one of the primary factors that has to be taken into account. Even before you look at the interest rates, you will have to consider the timeline or the actual duration that you will be keeping the home. This will decide exactly how many months or years you will need to pay-back the money you have borrowed.

    Are you planning on some home improvements in order to get top dollar on the sale of the house or are you looking to add some extensions to make your home more comfortable and spacious? This is an important question you have to ask yourself as the 2 types of loans will provide you the same result – they will give you the funds you need, but they serve very different purposes.

A HELOC is ideal for short-term goals & has adjustable rates that might change on a monthly basis and you might end up paying a very high interest in one month and a much lower one in another.

  • Costs / Fees- You will also have to know what the closing costs for each loan will be. This is also related to the timeline considerations. A HELOC will generally cost much less than a full refinance.

  • Interest Rate- This is one of the first things that borrowers will look at. Everyone looks for the lowest interest rate possible. But when it comes to home improvements, the interest rate is not always as important as understanding what the risk level of that particular loan is. If you need a loan for the short term- a HELOC will be more suitable even if the interest rate is higher.

Your choice between a HELOC and a full refinance depends of the level of risk you are willing to take over the time frame that you require the money. For more information and to understand whether a HELOC or a full refinance will be suitable for you, contact ResMac Home Loans.

Calculating The Net Benefit Of A Refinance Transaction

Calculating the net benefit of refinancing can be a challenging task if you do not understand what to calculate. We are going to focus on the net benefits of refinancing from the standpoint of lowering your interest rate.

Although there are several reasons to refinance, lowering your mortgage rate to save on interest payments over the term of the loan is the most popular.

Calculating the actual savings can be a tricky chore unless you know the difference between cash flow savings and interest savings. If your refinance objective is to only save on the interest by lowering your rate, then the interest savings should be done with the calculations below.

Calculating Interest Savings:

(Loan Amount x Interest Rate) / Months in year = Interest paid per month

($200,000 x 6% or .06) / 12 = $1,000.00

*Remember to do the calculation in the parentheses first*

We now know that you are paying $1,000.00 per month in interest. You should take the new interest rate you are getting with your refinance and calculate what your new interest payment will be.

($200,000 x 5% or .05) / 12 = $833.34

Now we need to find out the difference between the two interest rates.

Current Interest Payment – Proposed Interest Payment = Interest Savings

$1,000.00 – $833.34 = $166.66

Now you have figured out that by dropping your interest rate 1% on $200,000 you will be saving $166.66 per month or about $2,000 per year.

Awesome!

Anyone would want to save $2,000 per year, where do I sign… right? Not so fast, you’ll want to calculate the break-even point to find out how you will benefit after your closing costs.

Net Benefit Formula (Break-Even):

(Closing Costs – Escrows) / Interest Savings = Month of Break-Even

($6,000 – $1,000) / $166.66 = 30 Months

In other words, it will take 30 months for you to recoup the cost of your refinance. If you plan to keep your mortgage for at least 30 months then you might want to consider this deal.

Okay, now we can calculate your net benefit for refinancing with one more calculation.

(Monthly Savings * Months you plan to keep mortgage) – (Closing Costs –Escrows) = Net Savings

($166.66 * 120 months) – ($6,000 – $1,000) = $14,999.20

If you kept the mortgage for 120 months (10 years) you would save $15,000.

Okay, now you can find out where to sign.

Calculating the net benefits of a refinance is crucial in determining if it is strategic for you to refinance. Keep in mind that each mortgage is slightly different and you may need to adjust calculations accordingly.

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Frequently Asked Questions:

Q:  I heard that I should only refinance if I drop 1% on my mortgage is that true?

Some people say ½% , 1% to never. Every mortgage is different.

For Example: A no cost loan can have a 1 month break-even point with only a .25% drop in interest rate. Now that you know how to calculate your net benefit, you are able to figure out what may be best for your situation.

Q:  Why can’t I just compare my current payment to the proposed payment and figure out my net benefit?

You could just compare just the two payments if you wanted to find out your cash flow savings, but the current and proposed loans may have two different amortizations.

Let’s assume you currently have a 15 year mortgage and you’re comparing it to a 30 year mortgage. If both loans have the same interest rate and loan amount but the amortization is different, your interest savings per month would be $0. However, you are going to show a cash flow savings with the 30 year mortgage because of the longer amortization.

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Related Article – Refinance Process:

Four Possible Reasons To Refinance

A mortgage is generally the largest debt most homeowners have to manage.  It’s a good idea to give your personal real estate finance portfolio a check-up at least once a year.

Since there are many reasons a homeowner may choose to refinance, we’ll take a look at the four most common.

1.  Mortgage Rates Drop:

Typically, the most common reason that homeowners refinance their mortgage is to secure a lower interest rate. Interest rate and loan amount determines the total cost that a borrower will pay. The lower the interest rate, the less the overall cost will be. Interest is calculated on a daily basis and usually paid back to the lender on a monthly basis.

2.  Lower Payments:

Lowering a mortgage payment can be achieved by lowering the mortgage rate, lengthening the loan term, combining two or more loans or removing mortgage insurance.

3.  New Mortgage Program:

Refinancing an Adjustable Rate Mortgage (ARM) to a new Fixed Rate Mortgage (FRM), combining a first and second mortgage or paying off a balloon loan are three possible reasons to explore a refinance.

4.  Debt Consolidation:

If there is sufficient equity, sometimes paying off consumer debt by combining all debts into one lower monthly mortgage payment can significantly reduce the short-term deficits in a budget.  However, it’s important to keep in mind the total cost of that debt by adding it into a 30 year mortgage payment.

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Frequently Asked Refinance Questions:

Q:  Do I have to refinance with my current mortgage company?

No, you may choose any company to refinance your mortgage since the new loan will replace the existing mortgage.

Q:  Is it easier to refinance with my current mortgage company?

It is possible your current mortgage company may require less documentation, but this could add additional cost or a higher interest rate. Do your homework and shop around to make sure you’re getting the best deal.

Q:  Will I automatically qualify if I’ve never made any late payments?

No, you will have to qualify for your new refinance. However, certain programs will allow for reduced documentation like a FHA to FHA Streamline Refinance.

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Related Article – Refinance Process: