So you’ve got a bunch of equity in your home and you’d like to deploy it to purchase an investment property. Should you utilize a HELOC – Home Equity Line of Credit or Cash-Out Refinance? Let’s compare!
A refinance is essentially a new fixed-rate loan that replaces your existing mortgage, if you have one. When refinancing, you have the option to do a cashout refinance, which means taking out equity above what your current mortgage balance is. The formula to estimate how much equity you have to take out is generally 80% of your current home’s value minus the current mortgage balance. This is because most lenders will only allow you to refinance up to 80% of your home’s value. This equity is taken out and you can use it however you wish. The benefit of a refinance is that it is a fixed rate, meaning your payments will remain the same going forward for the entire period of the loan. However, you will need to pay a closing cost again, similar to when you first purchased your home. So it can be expensive.
A HELOC is similar to a credit card where you have a line of credit available to you. You’ll only be charged what you use. And if you pay it back down, then you have more credit to use again. However, the interest rate is variable, meaning that your payments could go up drastically if the rates increase. However, some HELOCs offer low teaser rates to get you in the door. A HELOC is much less expensive to set up than a refinance. Typically you will only be charged an appraisal and maybe a small fee for setting up the HELOC. Unlike a refinance, you will not pay closing fees again. A HELOC sits as a second-position lien behind your primary mortgage and is also typically only available for 10 years. At that point, it will need to be paid off or switched to a fixed loan.
So back to the original question? Which one should you use as an investor? If you’re doing a short-term investment like a flip or a BRRRR, where you can quickly get your money back out and pay off the loan, then you should probably consider a HELOC. On the other hand, if you plan on picking up a property that you will hold for more than 5 years, I would recommend a cash-out refinance so that you have the comfort of having a fixed interest rate and fixed payments going forward for the life of the loan.