HELOC vs Refinance... or something else?
HELOC vs Refinance... and other alternatives
Like many people, the biggest investment I have is my home (which I now rent out after moving for work). It's been a tremendous wealth generator in the short time I have owned it, with an annualized return close to 30%. With leverage, a little bit of appreciation can turn into a LOT of appreciation.
Obviously buying and remodeling the condo has been a good investment so far. But recently I have been asking myself if the equity in the house is being put to it's most productive use. I've also been a little nervous watching the value tick up on the Zillow z-estimate I get for free with Personal Capital... I have over $200k in equity all in one basket (the asset below is my home, so $475-277=~$200k).
Would it be better overall to take out some of the equity in the house and invest it in another rental condo or in the stock market? Unfortunately, the traditional options available for accessing that equity would both add to the monthly payment and send the rental cash flow into the negative.
HELOC or Refinance
The two traditional options for accessing the equity in a home are a Home Equity Line of Credit (HELOC), or Cash-Out Refinancing. Cash-out refinancing is dead simple: you take out a new mortgage for more money than you currently owe on your existing mortgage, then you pay off your existing mortgage and keep the difference. With a HELOC, the bank offers a fixed credit line with a maximum draw. In other words, you can borrow up to X amount, but you have the flexibility to borrow less. If you are comparing a HELOC vs refinance, LendingTree offers home equity loans, refinancing, and even reverse mortgages that you can review side by side.
Advantages and disadvantages of cash-out refi
A cash-out refinance is dead simple, which makes it easy to evaluate. Many people cash out refinance (or just refinance) when interest rates go down, since it enables them to retire their old mortgage at higher interest rate. It's also a little easier to manage than a HELOC because there is only one payment. Generally, rates are also lower with a cash out refinance vs HELOC's.
But, a cash-out refi is only really possible if interest rates at a macro level are lower than they were when the original mortgage was taken out. Since rates have been rising, that is less likely. A cash-out refi will also restart your amortization, meaning that you will be paying a higher portion of your mortgage towards interest than with your original mortgage (at least at the start).
If this all seems too complex, the best way to know whether refinancing makes sense for you is to type in your details into my refinance calculator.
Cash-out refinance summary
Positive: Simple and easy to evaluate
Positive: You only have one mortgage
Negative: Not a good idea if rates have risen significantly since your original loan
Negative: You will start a new mortgage so your amortization begins again
Advantages and disadvantages of HELOC's
As you might imagine because they are for shorter terms than 30-year mortgages, rates are usually a little higher with a HELOC. But, a HELOC can be a good option for someone who has an existing mortgage at a low interest rate. Since rates have risen since I bought my condo, a cash-out refinance would significantly raise my mortgage payment, whereas a HELOC would enable me to keep my original mortgage and simply tack on a new payment in a HELOC. The one downside to a HELOC is that is requires significant equity in the property, usually on the order of 40-50%.
Positive: Can do at any time, even if rates have risen
Positive: You keep your original mortgage and original amortization table
Negative: Higher interest rates than traditional mortgages
Negative: You need high equity
Choosing between a cash out refinance vs HELOC, or looking for other alternatives
Unfortunately, both refinancing and HELOCs are DEBT. They increase the amount due to the bank every month, which makes it harder to earn a profitable income while renting the condo. What I really need are alternatives to HELOC and refinancing that doesn't increase my monthly payments, but lets me take out some of the equity I have in the condo.
This means that if I were to sell a portion of my equity, I could potentially free up ~$80k in capital, while still retaining full control over the property and the requisite 20% minimum equity. Then, whenever I choose to actually sell the condo outright, Point will take a percentage of the appreciation in the condo, and I keep the rest as normal. Here's the catch: if the value of the condo goes down, I bear the brunt of the losses while they only participate partially. On the same token, they take an outsized stake in the appreciation. Unison and Point are very similar when it comes to the eventual sale - you can see a chart from Unison below detailing how a sale would look in different market conditions.
There are some important details to discuss. First of all, Point is the only one that will buy a stake while I am renting the condo out. Unison requires you to reside in the home. Point only sells stakes to existing homeowners. Unison will partner with people who are purchasing a home to sell equity in the initial purchase, making it easier to avoid PMI... the biggest ripoff in real estate.
I have no idea whether it would be best to go through with an equity sale to Point, but it does offer a huge range of possibilities that can enable some significant flexibility with minimal effort or additional debt.
What do you think? Is it worth the trade-offs?
Next steps: Keep track of all your investments -including your home- in one place
Sign up for a free Personal Capital account, you can track all of your investments and assets as you see below. Personal Capital will help you decide where to go with your next investment decision. It will even let you keep track of your home’s value with a free Zillow z-estimate.