What are the pros and cons of a HELOC vs. refinancing?

If you need funds to pay for a renovation or other big expense, there are several ways to take advantage of the equity you have built up in your New York City apartment or house.

Refinancing a mortgage is the option familiar to most owners. This allows you make changes to your first mortgage and lock in a rate over several years. A home equity line of credit, known as a HELOC, is an alternative to refinancing. Like a mortgage, you are still borrowing against your property but it functions more like a credit card in that you pay interest on the loan and only pay when you start using the line of credit. 

There are pros and cons when it comes to each product. The pandemic has made many banks and lenders much more risk-averse and it may be more difficult to access lines of credit. Higher unemployment means banks are concerned about a borrower's ability to repay and there's also been uncertainty about falling property values. This is especially the case in NYC, where in the early stages of the pandemic some banks suspended HELOCs or reduced the maximum loan-to-value rate they offered. 

Some restrictions are beginning to ease but Melissa Cohn, executive mortgage banker at Raveis Mortgage, says, "it’s still an issue even though the real estate market in New York City got busier in the past month or more." She says banks are still in "wait-and-see mode."

The products you're offered by a lender will depend on several factors, including the type of property you own, how much you want to borrow, as well as your reasons for borrowing. You may also come across a home equity loan known as a HELOAN, which differs from a HELOC by being a second mortgage rather than a line of credit. For more on all these differences, read on.

Accessing a HELOC

With a HELOC, you typically get a 30-year loan, where you get an interest-only line of credit for the first 10 years and you can keep borrowing and paying the money back over the loan period. You only pay the outstanding balance once you start using the line of credit.

Cohn says it can work for someone who is looking for money temporarily—someone who intends to repay it and not keep the debt outstanding for a long time. For example, if you might have an immediate home repair, or want to buy a car, or pay off a credit card debt and have a bonus coming and will be able to repay it. 

However, unlike a mortgage, the rates are not locked so there's more risk involved—if the rates rise, your repayments will too. Even if the HELOC offers teaser rates, Sklar says they typically go up after a period of time.  

When rates are as low as they currently are, a HELOC might not be the best solution, Cohn says. "They only have one way to go—and that is up. If you have a line of credit, your rate floats monthly with the prime rate," she says. 

Sklar says he frequently sees people max our their lines of credit and then do a cash-out refinance to pay it off. A HELOC might, however, suit someone who is flipping a property and can reliably pay back what they've borrowed. Even so, some lenders have pre-payment penalties, so it's important to know exactly what you are getting into. 

Unlike a mortgage, there's no tax advantage to a HELOC. "According to the new tax code, lines of credit are not deductible as itemizing tax right offs," Sklar says. So if someone is trying to to angle their mortgage for tax savings, a line of credit isn't the answer. 

As with any of the riskier financial products, they can sometimes complicate your other transactions. Late or missed payments can impact your credit score and Sklar says, in his experience, if you refinance and have these lines of credit, it can make the process more difficult. 

There are some added complications for co-op shareholders. 

"Anytime there is financing involved with a co-op board, be it a HELOC or a refinance, the co-op board has to approve the financing," Cohn says. In a co-op, getting approval for a HELOC "is much harder and the loan-to-values are much lower," she says. 

Tapping into funds by refinancing

Mortgage rates are currently around 3 percent and when they are this low, it can make sense to refinance your property and lock in a favorable rate. It's also a way of accessing the equity in your primary residence. Depending on credit scores, how much you want to borrow, and the value of your apartment, you may be able to refinance for a higher amount than your current mortgage and take out funds.

If you don't see yourself paying back the money within a couple of years, refinancing is a safer route. For example, you might need to pay for a major home renovation or want to fund your kids' college education, in which case you'll want to pay for it with regular, fixed monthly payments. 

"If you plan on doing work to the house or the condo, it's better to take out a mortgage," Sklar says. 

Refinancing also has tax advantages over lines of credit and is more readily available to co-op shareholders—albeit with board approval. 

Cohn explains that mortgage interest is deductible according to the new IRS ruling to $750,000 worth of mortgage debt and if you owe less than the allowance, you can refinance and it can still be tax deductible. 

One other issue to keep in mind is the mortgage recording tax. This doesn't apply to co-ops because of their shareholder structure, but if you are refinancing a condo or townhouse, you'll need to factor in this cost. The tax is almost 2 percent of the loan amount. It's possible you may be able to avoid this cost by assigning the mortgage under a Consolidation, Extension, and Modification Agreement, (CEMA) from one lender to the next, but Cohn warns there may still be fees involved, not every bank will do it, and it can take time. 

"If any of the documents of your existing mortgage aren't perfect, you may be rejected and if you want the money quickly, some banks are taking five months or more to give a CEMA," she says.