Cash-out refinancing and HELOCs are expected to surge in 2022. But are they right for you?
If you’re looking to turn the home equity you built into cash in your pocket, then you’re in good company.
Demand for home equity-based loans such as cash-out refinancing and home equity lines of credit, or HELOCs, soared during the pandemic, and the trend is expected to continue in 2022 and beyond. Cash-out refinance replaces your existing mortgage with a bigger loan than what you currently owe so you can take out the difference in cash. HELOCs, on the other hand, are often a second mortgage that functions as a revolving credit line separate from your primary home loan.
With the steady growth in home values over the past decade, more people now than ever can access equity-based financing to borrow at a cheaper rate. But which is better — a HELOC or cash-out refi? Personal circumstances will always be the key deciding factor, but for most borrowers, we think HELOCs take the top spot.
Why are HELOCs going to surge?
HELOCs outshine other financing alternatives in an environment of rising interest rates.
Since a HELOC is secured by the borrower’s primary residence, HELOC rates are typically much lower than those applied on unsecured loans. For example, the average personal loan rate is around 10% while the average credit card rate is over 16%. In contrast,10-year HELOC rates are just over 4%. It’s easy to see how personal loans and credit cards become even less affordable and more risky as rates climb.
Beyond attractive interest rates
HELOCs also offer more flexibility than other home equity-based lending products. Unlike a home equity installment loan where you receive a lump sum upfront, most HELOCs allow you to draw funds as needed, so you’ll only pay interest on the credit you actually use.
With cash-out refinancing, you’ll have to refinance the outstanding amount on your primary mortgage plus the equity you want to take out. If you’re currently paying low interest on a fixed rate home loan, then you could end up paying more with a cash-out refi because the refinancing rate on your new loan is likely to be higher. By setting up a HELOC, you can keep the lower interest rate on your primary mortgage and utilize a separate line of credit to convert equity into cash.
While rate hikes aren’t certain, inflation is hurting our purchasing power and the Federal Reserve is committed to stemming further price growth. It has already lifted interest rates twice, and economists widely predict five more rounds of increases this year to reach a target rate of 2.9% by early 2023. The bottom line? The era of low interest rates is over — borrowers must consider the interest factor when choosing a loan.
Choosing a HELOC over other finance
Let’s say you’re remodeling your kitchen and the expected cost is $25,000. Since you’ll be paying for the expenses as they come up, you’re considering financing the project using either a credit card or a HELOC. Here are key reasons why a HELOC is likely to be the better option:
Interest payments. The average credit card interest rate is 12% higher than the average HELOC rate. Credit card rates tend to be variable too, meaning they can increase when the official interest rate goes up. Unless you open a new credit card with a promotional rate and you have the cash reserves to repay the amount in full before the promotion period ends, a HELOC will most likely cost you less in interest. HELOC rates could be fixed or variable. For example, with Figure’s HELOCs, the rate applicable to each draw is fixed at the time of the draw, meaning it won’t change over time.1navigates to numbered disclosure
Tax deduction. You could potentially deduct interest on home equity debt if your renovations are substantial.2navigates to numbered disclosure However, there are no tax advantages to using credit cards for home improvements.
Fees. Credit cards often come with annual fees. Depending on the provider, the fees on a HELOC are minimal and may be limited to an origination fee with no ongoing maintenance costs.
Acceptance. Contractors may not accept credit card payments while funds from a HELOC are available in cash.
Spending limit. With the average credit card limit being around $30,000, there’s a risk you’ll have insufficient credit to pay the bills if the project costs more than you planned. Being secured debt, your spending limit is likely to be much higher with a HELOC.
Of course, you could use cash-out refinancing to pay for renovations too. However, with a cash-out refi, you’ll likely pay more in closing costs — typically 3% to 5% of the loan amount. And your monthly payments will go up if the rate on your new loan is higher than the rate on your existing loan.
Why you need a HELOC
In addition to home improvement projects, other smart ways of using HELOCs include:
Meeting unexpected expenses like medical bills and motor repairs.
Cushioning financial impacts of unexpected life events like losing your job, getting divorced, or recovering from major illness.
Consolidating credit card debt and personal loans. By swapping high-interest debt with a low interest HELOC, you can significantly reduce monthly repayments and get out of debt faster.3navigates to numbered disclosure
Paying kids’ education costs such as tuition, fees, room and board, textbooks, and living expenses. You can use PLUS loans or private loans instead but these are likely to be more expensive because they’re unsecured.
Taking advantage of business opportunities. Whether it’s to start a business or fund its growth, a HELOC is likely to be cheaper, more accessible, and quicker to apply for compared with traditional business loans.
There are no restrictions on how you use HELOCs, which is why they’re such a handy addition to your financial toolbox.
When is a HELOC not right for you?
Given the previous point, you’ll need to have strong mental powers — aka financial discipline — to resist splurging on non-emergencies so you don’t accumulate unnecessary debt.
If you prefer predictable repayments and you know exactly how much you’ll need to borrow, then a home equity installment loan could be a great option because it comes with a fixed repayment schedule.
Another consideration is how you feel about having multiple liens on your property. A HELOC exists as a separate loan, so getting one usually involves creating a second claim on your home. If you want to avoid this, then you might want to head down the cash-out refinancing path instead.
How a HELOC from Figure works
Figure offers lines of credit starting from $20,000 up to $400,000 with loans terms ranging from five to 30 years. Depending on your FICO score and where you live, you could be eligible to borrow up to a combined loan-to-value ratio of 85%.
Let’s say the current market value of your home is $600,000 and your mortgage balance is $200,000, so the value of your home equity is $400,000.
Figure's digital application offers faster and easier loans for borrowers. There are no account opening fees, maintenance fees, or prepayment penalties — just an origination fee to cover the cost of providing the loan4navigates to numbered disclosure. The application process is 100% online and takes minutes to complete. The best bit? You can have funding in as little as five days.5navigates to numbered disclosure
