REFINANCING? Choose between a Home Equity Loan and an Equity Line of Credit

Should You Fund Home Improvements with a Refinance?

 From: Dottie Wells  Blog  -- Branch Mgr L&F Bethany Beach DE office    

Maybe you're considering upgrading your house so it has a higher resale value. Or perhaps you just want to be more comfortable where you are for the long term. Either way, you have to think about how you're going to pay for these changes. Are you going to refinance to get the needed cash? Before you do, let's weigh some important factors.

Home Equity Loan vs. Equity Line of Credit

To refinance in order to make home improvements you can either take out a home equity loan or an equity line of credit. Both offer pros and cons depending on your specific situation.

A home equity loan usually costs much less than a home equity line of credit (HELOC). With a home equity loan, you are taking out some of the equity in your home in order to fund repairs. With a home equity line of credit, you are borrowing more money which will be tacked on to the overall cost of your mortgage.

Each type of credit will carry with it certain costs. 

Taking out a first or second mortgage (cash-out refinance / equity line of credit) will increase the overall debt remaining on your mortgage. It can reduce your resale value and throw off your debt-to-income ratio when you sell, making it harder to put down 20% on a new house, thus avoiding paying for Private Mortgage Insurance. 

An equity line of credit can reduce your monthly mortgage payment and your overall interest rate on your mortgage. It is not an optimal solution unless you intend to remain in your house long enough to repay the loan.

Over the long run, when you take out a HELOC, you will end up paying close to 1% interest on your home improvement loan. The average interest rate on a home is just over 5%. Anything that will push that additional debt up any higher will increase the overall cost of your mortgage and reduce your resale value.

Why Are You Making Improvements?

Next you have to consider why you are making home improvements. If you are doing it in order to fund a major project because you are putting your home up for sale soon, a home equity loan is better over the short term. Often you get that money right back upon resale if you make the right repairs.

What Types of Repairs are You Considering?

Depending on where you live some improvements have a bigger bang for their buck. If you live in the North and Northeast where there is snow and rain, a home equity loan is better used to fund a new roof or plumbing repairs.

If you live on the West coast or in the South, outdoor improvements have the best ROI. Things like a patio or deck, basement renovation, and home theaters have the best ROI. 

For repairs specifically needed to prepare your home for resale soon, a home equity loan is the better choice.

Considering a Reverse Mortgage? Discuss this home equity loan with your adult children.

Reverse Mortgage and Your Adult Children

RISMEDIA, Saturday, January 23, 2016— (TNS)—You’re thinking about getting a reverse mortgage. Should you discuss your plan with your adult children? Maybe. Every senior homeowner’s situation is unique.

“I wish I could give you one best practice that’s optimal for every family, but it’s more complex than that,” says Joseph Goetz, an associate professor for the department of financial planning, housing and consumer economics at the University of Georgia and an editorial board member of the Financial Therapy Association.

Reverse Mortgage

A type of home equity loan that is available to homeowners age 62 or older. No repayment is required until the borrower dies or moves out. At that time, the principal and accumulated interest are repaid, usually by selling the house. Most reverse mortgages are insured by the Federal Housing Administration, which calls the loan a home equity conversion mortgage, or HECM (pronounced HECK’m).

As a general rule, Goetz says, more communication is better, but family dynamics and the family’s financial culture are important, too.

“In some families,” he says, “the kids would be really upset if Mom and Dad gave up the house without talking to them. In other families, they would not.”

A reverse mortgage doesn’t necessarily involve giving up your house — at least, not as long as you live there. But Goetz’s point is well-made: Many adult children have an emotional attachment to their childhood home or expect to receive their parent’s home free of any encumbrance upon the parent’s death.

Death: A Bad Time to Surprise the Kids  

A reverse mortgage discovered after the fact can come as a surprise, shock or disappointment, suggests Buz Livingston, a financial planner for Livingston Financial Planning in Santa Rosa Beach, Fla.

He recalls a client whose father and stepmother took out a reverse mortgage without their daughter’s knowledge. Another client’s parents took out a reverse mortgage and informed one sibling but not the other.

“The children need to be involved just to make sure everybody is on the same page and there is not a big surprise,” Livingston says. “Just keep it simple. Say, ‘This is what we are going to do and if this (house) is something you want to hold on to, speak up.’”

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You Can Inform without Seeking Advice

Whoever will be responsible for your estate should be aware of your reverse mortgage and the options to repay it, says Cara Pierce, a financial specialist at ClearPoint Credit Counseling Solutions in Fresno, Calif. Many times, that executor or administrator will be one of your adult children.

“It doesn’t mean you have to get them involved or take their advice,” Pierce says. “But if I am setting up my son to be trustee, it would be nice if I told him that if I stay (in my house) until I die, he needs to make sure to pay off the loan on my behalf.”

What Triggers the Loan Repayment?  

Heirs aren’t personally responsible for the debt, but the house will have to be sold to repay the reverse mortgage unless there are other ready funds, retirement savings or life insurance, or the adult child can qualify for a new mortgage.

Disclosure also matters because if you move out of your home for an extended period, the reverse mortgage likely will have to be repaid, which could trigger the sale of the house if there aren’t other assets to pay it.

“It has to be your primary residence,” Livingston explains. “If you are living in a nursing home, it’s not your primary residence and the bill comes due.”

Not Just about Money

The conversation, if you decide to have one, should be aligned with your goals, which might include a desire to address your adult children’s emotional concerns, expectations or sibling rivalries, Goetz suggests.

“If one of the parents’ goals is their adult children’s happiness or to leave a bequest for their children, a financial planner will say, ‘You need to bring your kids into the conversation because that’s consistent with your goals.’ Another set of parents could say, ‘My kids are doing fine. It’s my business, and my kids won’t feel any adverse emotional reaction to not knowing I took a reverse mortgage.’ In that case, you don’t need to tell your kids,” he says.

When to Talk about It

The house itself or your broader financial planning agenda could be entry points to start the talk with your adult children.

Another option would be to include your adult children in the financial counseling that’s required for some types of reverse mortgages. Pierce says a lot of housing counseling is done over the phone and adult children can participate in the call.

Livingston says he’s “not anti-reverse mortgages,” but he also says you should speak with your adult children before you get one.

“I always make a point of hammering pretty hard to my clients that they really need to talk to kids about it,” he says. “It’s important to have that discussion.”

Marcie Geffner writes for Bankrate.com.