Is a cash-out refi better than a HELOC?

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Dear Dr. Don,
I currently have a 15-year fixed-rate home loan at 3.75 percent. The bank appraised the house at $275,000 and the balance on my loan is $186,000. My credit score is 829 and my husband's is 732. I'd like to refinance this loan and take out about $20,000 in cash. The bank says that, without the cash out, the loan will be about 2.7 percent for a 10-year fixed-rate loan. It'll be 3.25 percent with cash out. Closing fees will be about $1,900. What should I do?

Thanks,
-- Rosa Refi

Dear Rosa,
That's a tough one. You have some options, including a cash-out refinance or a home equity line of credit, or HELOC.

What's the goal: to save money in refinancing, get cash out or both? Paying an additional 0.55 percent interest for the privilege of taking out cash seems excessive with the equity you have in your home and your solid credit scores. But it's actually not excessive for a cash-out refinancing. Since gaining access to the funds is one of the drivers behind the refinancing, then abandoning it to get the lower interest rate doesn't make sense.

Over the 10-year term, when refinancing just the outstanding loan balance of $186,000 you'll pay an extra $5,662.38 (pretax) in mortgage interest expense by taking the 3.25 percent rate loan versus the 2.7 percent rate loan.

As the table below shows, you're paying an extra $5,600-plus over 10 years for the privilege of borrowing that $20,000 today. How important is it for you to tap your home equity to get access to this money?

Which refi rate to take?

headline?headline?Difference
Loan amount$186,000.00$186,000.00None
Loan term (months)120120None
Interest rate2.7%3.25%+0.55%
Monthly mortgage payment$1,770.39$1,817.57+$47.18
Total interest expense (pretax)$26,446.49$32,108.87+$5,662.38

You could take out a home equity line of credit or a home equity loan to get the $20,000 at lower closing costs. However, you wouldn't capture the interest rate savings on the outstanding loan balance. Also, the interest rate on the home equity line or loan is likely to be significantly higher than the 3.25 percent you're being offered on the cash-out refinancing. I say you should go ahead with the cash-out refinancing.

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