Which is Better – Home Equity Loan Or a No Cash Out Refinance?

Every mortgage or refinance needs a target; something larger we’re trying to accomplish beyond just buying/refinancing a home or investment property. The best loan isn’t always the loan with the lowest rate, but the loan that helps you move forward financially.

Here are a few “Refinance Rules” you may want to consider.

These are rules aren’t strict-rather they are just like the sites on a rifle…they help everyone get a focus.

Because a mortgage should not be an end in and of itself, but a means to a bigger end.

Top Refinance Rules…

#1) Eliminating Consumer Debt: (Non-tax deductible)

#2) Have a Savings Cushion: Ideally 3-6 months in a liquid interest-bearing account.

After you close on a home loan, you’ll need a savings cushion. They focus so much on the mortgage rate, that they’ll empty all their savings to buy a home. Not a good idea! Tell me, does it matter if you get the lowest rates in Texas if you don’t have $500 left to your name after closing?

This is one reason why people should consider 95% loans. There’s a myth out there that most people with good credit put 20% down–but most the 80-90-95% home loan clients are PhDs, teachers, physicians, engineers, Aggies, OU Sooners, who could easily put 5-10% down. They choose to keep mortgage down payments to a minimum so they can put more money elsewhere, like money markets, buying investment homes, etc.

Refinance Rule #3) Pay of home before 30 years and save a ton in interest…..you shouldn’t pay for your house 3 times.

Go with the loan that moves you forward financially. If this is a 15 year refinance-great. But if you have debt and you’re paying lots of money out each month-your best bet is going with a home equity loan. The fewer bills you have the better.

Mortgage rates go up and go down…so chasing a magical rate is kinda stressful. And waiting for the market to come your way takes you out of control of your finances. I mean, if rates are 7% and you’re waiting on rates in the 4% range, you may be waiting a few years.

Have a strategy when going into the home loan or refinance- and “use” the mortgage to execute your game plan. Mortgages are just tools. And choosing the right tool is very important.

Ask yourself: “Is there a better way to approach a home loan or refinance than just trying to get some “magical low rate.” Naturally, rate is important, closing costs are too, but let’s try to blend two objectives. The more things you can accomplish with your refinance the better you will be and the better ROI you get from your closing costs.

For most people, they only aim at the mortgage rate. So what do mortgage companies do…they give low rates to these people. But With PMI…

PMI: Consider this, if your rate is 6.00% and the house payment is $1000. But your PMI is $200 month do you still think your rate is 6% if you’re paying $1200/month? Why don’t more people avoid PMI-it’s almost always a waste of money. You guessed it. Home loans that are 80/20 or 80/10 or 80/15s have higher rates because these are riskier than single loans.

And did you know mortgage people make more money on single loans vs. 80/20s or 80/15/5 loans?

Or take 95% home loans…these rates are higher than 20% down. But sometimes people want to keep their money vs putting it towards a home. Maybe they are self-employed and can get a greater return on this money elsewhere or maybe they can take the 5% down and eliminate all their consumer debt. Each person is different and has different goals and incomes.

So how do we actually blend these goals of low rates with financial planning? What do the “Refinance rules” look like in real life.

Someone calls and says “I want to lower my rate. I want to lower monthly bills.” Okay, great. That’s pretty general. Sorta like most high school boys want a nice car and a pretty girlfriend. Who doesn’t want this?

But what if we took at bigger approach to things and blended your goals for a refinance rule and added “eliminate consumer debt” to the equation. What loan would we choose if the objective was to reduce your family’s overall monthly expenses-not just the mortgage?

Just focusing on the mortgage is fine-who doesn’t want a lower home payment. But when we look at the mortgage in context of the overall family expenses we are really doing is improving your overall financial plan. This is what a financial planner truly needs to do. And all financial planning begins on the mortgage level. Because when you are out of debt you have more money to save, to invest, to build towards retirement.

And it all this begins on the mortgage level.

What’s your current refinance goal? Maybe your situation might be “Hey Mr. Mortgage guy, what loan do you suggest that will help me retire at age 55.”

Let’s talk about Home Equity Loans: We recently helped a client get out of debt with a home equity loan. They’ll save over $900/month. That’s $10,800 a year they have in their checking accounts. Not theoretical money. Not the What Would Dave Ramsey Do (WWDR) approach of “cancel your cable and take the difference and put it into a municipal bond so you can make 1.3% over 10 years” But real money.

Financial planning truly begins on the mortgage level.

Home Equity Loans: If you are going to refinance, at least look at something larger than the mortgage rate. For example, let’s say you’re current mortgage is 7% and rates are at 5.75%. You’d really like to refinance and lower your bills. Let’s say, if you took advantage of the 5.75% you’d save $100/month. Hey-that’s progress!

But what if you took some equity out of your home and paid most/all of your non-tax deductible debt off in the process? This probably would save you $500-$700 month. Then you could take some of the savings and apply it to your principal and pay a 30 year mortgage off in 15-20 years. That is a very important step-and here is where I agree with Dave Ramsey-you must have a budget because without this you’ll get back into debt.

Refinancing to get a low rate is good. The second approach moves you to an entirely different financial situation.

I mean, you’re going to have closing costs anyway. Why not go with a home loan that will move you forward financially vs. one that will just save you $100.

Some people think home equity loans are not good. Gurus like Dave Ramsey don’t encourage them. But if the numbers make sense-who’s to argue? Is Dave Ramsey going to pay your bills for you?

Dave teaches some great time-tested fundamental principles. Most of which I agree with. Budgeting, saving, low debt…but the more I listen to his show the more I see his main goal is this: ” Get to zero.”

“Don’t owe anyone anything”…which is good. He even throws some Bible verses around. Who could disagree with a simplistic message of getting to zero?

I don’t think you win the financial game by getting to zero. I believe you get there when you have money. When you have assets. And anyone who takes a black and white approach to anything, I tend to disagree with. Few things in life are 100%-and money is no different. If you called Dave’s show and said “Hey I make good money but I my retirement is iffy at best. I only have 30K in retirement and I’m 50 years old.” He’s likely to suggest you need to budget more, maybe cut out some vacations and buy another book of his.

If you called, me and you’d didn’t have any goals of your own-I’d probably suggest the things that Dave suggest- but I’d encourage you to buy investment properties or some other growth vehicle. If your IRA is growing at 1-2% and we find some properties that are growing at 3-5-7% I’d might even encourage you to put more of your savings towards a higher yield vehicle like established real estate. No specs stuff. Then, with the right planning and discipline, you could retire with several properties that have equity.

Then, with these assets you could sell them or keep them and enjoy passive income during your retirement years. Whichever approach you take-you’ll need to get some points on the board because “getting to zero” is no long term game plan. Most people need to take the Dave Ramsey PLUS perspective…. Take the budgeting, savings, getting out of debt time-tested fundamentals–PLUS buying and keeping assets and starting businesses, even if you have to incur debt.

Because getting to zero should not be the goal and every mortgage should have a specific purpose to move you forward financially.