Dear Dr. Don,
I am considering refinancing my home. My wife and I are 52 and have a mortgage balance of $152,000 at 5.5 percent with 23 years remaining on the loan. Our home is worth about $300,000. We need to do some home improvements — new windows and a furnace. We’re having trouble deciding whether to go with a cash-out refinancing or a home equity loan.

It looks like we can refinance for about 4.375 percent with a 20-year mortgage, paying approximately $2,000 in closing costs. We would like to get about $20,000 for the improvements. Home equity loans seem to be about 5 percent to 7 percent right now.

It seems like a cash-out refinancing would save us thousands of dollars over the long term versus keeping our existing mortgage and getting a home equity loan. Can you please help us decide what to do?
— Richard Refi

Dear Richard,
It’s a fairly straightforward decision to do the cash-out refinancing: You can improve the interest rate on your existing first mortgage, shorten its term by three years and get a lower rate on the refinancing than you can on the home equity loan. Plus, the expected closing costs are only $2,000.

You’re looking to minimize total interest expense on an after-tax basis. At this writing, Bankrate’s national average for a home equity line of credit is 5.59 percent, and its national average for a home equity loan is 7.27 percent. The 4.375 percent mortgage rate on the cash-out refi trumps both of these rates.

I ran the numbers assuming that the HELOC was a self-amortizing loan, meaning the monthly payment was sized to pay off the loan over its 20-year term. Making interest-only payments in the early years of the HELOC would increase the total interest expense of the loan.

Bankrate’s refinance mortgage calculators can put a finer point on the interest savings for you.

Cash-out refinance vs. HELOC
Cash-out

refinance

Existing

mortgage

HELOC Existing

+ HELOC

Loan amount $172,000 $152,000 $20,000 $172,000
Loan term 240 months 276 months 240 months
Interest rate 4.375 percent 5.5 percent 5.59 percent
Monthly payment $1,076.59 $971.72 $138.60
Total interest $86,381 $116,194 $13,263 $129,457
Closing costs $2,000 $750 $750

As you can see, your total interest expense plus closing costs is about $42,000 less on a pretax basis than keeping your existing mortgage and financing the improvements with a HELOC. After-tax savings would be lower, but still would point to the cash-out refinancing.

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