Borrowing against your home
Real estate values have increased in many areas, opening up opportunities to borrow against home equity — once you understand the home equity loan vs line of credit, or HELOC.
- Home equity loans are installment loans, usually with fixed interest rates
- HELOCs (home equity lines of credit) are revolving accounts like credit cards
- The best choice depends on how you plan to use the money
Both loans are relatively inexpensive ways to borrow because they are secured by your home. Each loan has pros and cons.Verify your new rate (Aug 20th, 2018)
Home equity loan vs. line of credit (HELOC)
Two of the most popular are: a home equity loan and a home equity line of credit (HELOC). But which is better? A home equity loan vs. a HELOC?
That depends on your needs and goals. Each option involves tapping into your home’s appraised value to borrow money. Each has its pros and cons. Digging into these differences can help you make a more informed decision.
Learn the facts and what’s required for each. Do the math and decide which is the better fit for you and your finances. Either option can prove handy when you need cash soon for a major project or expense.
Home equity loans explained
Both home equity loans and HELOCs are mortgages backed by your home. The chief features of most home equity loans include:
- Delivers a lump sum at closing
- The rate and payment are usually fixed
- You pay the loan over a pre-determined term, such as 10 or 15 years
Your interest rate and ability to borrow depend on your credit rating and what percentage of your home equity you borrow. Better credit scores and lower loan-to-value ratios get you better rates. And always compare quotes from several lenders, because rates vary considerably.
A HELOC also allows you to borrow against your home’s equity:
- When you close a HELOC, you get a credit line you can draw upon and repay repeatedly
- HELOCs usually come with variable interest rates, but some allow you to convert to fixed rates
- HELOCs have pre-determined terms, ranging from five to over 20 years.
- HELOC terms have a drawing period in which you can tap the line and a repayment period in which you repay the balance and cannot take any more money
A HELOC’s interest rate is a preset variable rate based on current prime rates. But you only pay interest on the amount you borrow; plus, there are little to no closing costs. You begin to make minimum monthly repayments once you have a balance owed.
Pluses and minuses
Theresa Williams-Barrett with Affinity Federal Credit Union, says each option has its pros and cons.
“With a home equity loan, borrowers can qualify for relatively large loans. Also, the interest rate is fixed. So you can count on predictable, stable payments through your repayment period,” she says. “But you may pay closing costs and other fees.”
HELOCs, by contrast, often have lower interest rates and fees. “And they offer longer repayment terms. This keeps your borrowing costs low,” Williams-Barrett notes. “They provide you with access to cash only when needed. You can choose if and when you want to draw on the credit line or not.
“You can decide to make minimum payments or pay the line in full. Also, during the draw period, you only have to pay the interest owed. You can pay the principal later.”
On the other hand, a HELOC’s variable interest rate can create financial uncertainty. “It can be easy and tempting to over-draw, too. This would tap out most or all the equity in your home,” she adds.
Which choice is best for you?
What’s your best option? Jed Mayk, attorney/partner with Hudson Cook, LLP says that depends on your needs.
“A home equity loan might make more sense for a borrower who needs a set amount of money for a specific purpose. This can include a home improvement project,” he says.
Other uses that might be better served by home equity loans include:
- Debt consolidation
- Extensive home renovation requiring a large upfront payment
- Real estate
But a home equity loan may not be the best choice “if you are unsure of the exact amount you may need now or in the future,” says Johnna Camarillo with Navy Federal Credit Union.
A HELOC might make more sense for those who need to borrow different amounts over a period of time, per Mayk.
Examples of good uses for HELOCs include:
- Regular tuition payments
- Extended “pay as you go” home improvement
- Providing emergency cash flow for a new business
HELOCs are best for those who don’t need instant access to their home’s equity.
“A HELOC can be used like a credit card. It’s great to have as a rainy day fund if your home needs emergency repairs,” Camarillo says.
Mayk says HELOCs are also popular with folks who have irregular income patterns. “This includes those paid a base salary and quarterly commissions.”
Other matters to consider
The benefit of either option is that it gives you more flexibility with your finances. “But you need to make sure you’re comfortable with how the monthly payments will impact your budget,” says Camarillo.
To qualify for either, you’ll need a good credit score.
“A score of 620 or lower will make it hard to secure a loan or HELOC. Higher scores may provide access to higher loan amounts and lower costs,” adds Williams-Barrett.
You also need to be confident in your earnings and job security.
“Establishing a secure, constant source of income is very important,” Williams-Barrett says.
In addition, note that interest for home equity loans and HELOCs may or may not be tax deductible. Check with a tax professional.
Lastly, there’s a third choice worth considering: a cash-out refinance of your first mortgage.
“This is an attractive option if doing so lowers your interest rate,” Camarillo suggests.Verify your new rate (Aug 20th, 2018)