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
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.
|Loan term||–||240 months||276 months||240 months|
|Interest rate||–||4.375 percent||5.5 percent||5.59 percent|
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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