How to Decide Between Refinancing or a Home Equity Line of Credit

Choose either a mortgage refinance or a home equity line of credit.

According to the Federal Reserve, the average cost of a home mortgage refinance is between 3 and 6 percent of the loan amount. This makes the decision to procure a mortgage refinance a very expensive one. One alternative to a full refinance is to get a home equity line of credit. Through the analysis of the two options, you can come to the best financial decision for yourself and your family.

Difficulty:

Moderately Easy

Instructions

1. Ask your lender for a quote on both a home equity line of credit and a home mortgage refinance. Ask for copies of the Good Faith Estimate and Truth in Lending Statement on both options.

2. Look at the overall closing costs for the mortgage, outlined on the Good Faith Estimate. Compare those to the home equity line of credit. Many times, if you keep the home equity line of credit for 3 years or more, the closing costs are waived.

3. Compare the monthly interest rate and terms of both loans. Typically, the term of the mortgage refinance will be longer than the home equity line of credit, however, the rate is usually lower and can be fixed.

4. Look at the APR (annual percentage rate) outlined on the Truth in Lending Statement of both loans. This is the numerical representation of the total cost of the debt for a full year, including the monthly interest and the closing cost. The loan with the lowest APR is the cheapest overall loan.

5. Look at your budget as a whole. Can you afford the extra payment that is associated with the home equity line of credit? Will the mortgage refinance actually result in a lower total payment? Which is more important for your family, a cheaper debt or a lower monthly payment? The last question will more than likely answer which loan option you and your family should take.

Tips & Warnings

• When calculating the home equity line of credit's monthly payment, ask your lender to give you the payment with the loan extended to its fullest, at the highest possible interest rate. For example, if the line of credit is $40,000 and the interest rate cap is 9 percent, ask the lender to calculate the monthly payment on $40,000 at 9 percent interest. Use that number in your budget figures to help you decide which option is best.

• If the interest rate on either loan is variable, it could rise or fall with inflation. Be sure to note the cap on the interest rate--or the highest possible rate that it can go. If this number is too high for your budget, forgo the variable rate debt.

References

• Federal Reserve: A Consumer's Guide to Mortgage Refinancing
• Federal Reserve: What You Should Know About Home Equity Lines of Credit