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Let's say that I want to buy a new Mac, but I need to modify my home by adding a second floor with a bedroom and bathroom so that the Mac has a nice place to stay. What are the pros and cons to a Home Equity Loan vs. Refinancing the existing mortgage to get money for the project? I know that HELOCs would require an interest rate that is pegged to the Prime rate. My current mortgage is actually at a REALLY good rate, so I'm hesitant to give that up. Let's also assume that this is my first home, it is in a great neighborhood, but my home is the worst home on a block of very nice homes, so it would probably increase the value substantially. We'll also mention that my town has been almost completely unscathed by the recent mortgage implosion, but it also felt no effects from the crazy housing bubble either.
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If you plan on paying off the amount you take out within the next couple years, I'd get a HELOC. Plus you'll pay a lot less fees. Not only that, but if you've had your mortgage for a while, even if you get a lower rate the final loan value may be much more than just the amount you take out.
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My standard response is "do the math". Excel is your friend. You haven't given us enough data to respond. You need to run several different scenarios making various assumptions about how long you'll keep the house, what the maximum and expected variable interest rate increases would be, what the extra cost of a refi would be, how much your improvements will increase your house's worth etc. The answer should then be obvious. In your calculations, don't forget to throw in the impacts on your tax deduction and the impacts of any major house improvements on your property taxes (that's right, in many jurisdictions taking out a large value building permit will result in a property tax reassessment...outrageous I say...I spend a bunch of money on improving the house and the taxman taxes me on what I put into it!!!!???).
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Davester, if I knew all of that information I wouldn't be asking for help, advice, or how to figure out that information. In fact, if I knew all of that information, and what to do with it, I could make a fortune helping other clueless people too figure out what to do. Who knows how long I'll have a job. We're all one bad CEO away from un-employment. So far my city has not been affected either way by real-estate fluctuations that seem to be hitting other cities, but history would seem to indicate that improvements to my home, in a good neighborhood would improve the value. I intend to live here for the rest of my life, but if my wife has triplets, or Mt. St. Helens erupts again, I may change my mind.
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I didn't say you had to know all of that information, I suggested that you run several scenarios making different assumptions. There is no way answer to your question with any reasonable accuracy without getting a lot more details, but the nice thing is that you're dealing with hard numbers, so the calculations are straightforward and the answer is always the one where you have expended the least amount of money at the end. It depends a lot on what the future holds and what your current loan balance, terms and extra funding needs are.
Whenever I've come up against this kind of question myself, I've tried a number of scenarios and have picked the solution which seemed to fit with the most likely of those. What is more common is that you run a bunch of scenarios and they all give you close to the same answer. Just make a couple of assumptions (i.e. keep house 10 years vs 5 years, maximum vs stable ARM rampup, refi vs heloc...I'd assume that your tax bracket stays the same, and you know what your local property tax rate is that will be applied to any significant improvements) and calculate how much money you will have expended at the end of 5 and 10 years for each of those. You can also use zillow to see what houses in you neighborhood similar to yours but with your proposed improvements are worth.
