Do you need cash and own your home? Do you have equity? If so, you may have the solution to your problems right in front of you! Homeowners needing cash may be able to leverage their property with a home equity or HELOC loan and use it for how they see fit.
Equity is defined as the current value of your home minus the amount of any mortgages against it. So if your home is worth $200,000 and you owe $125,000 on the mortgage, you have about $75,000 in equity available to borrow.
Once you determine how much equity you have in your home, now you need to decide what type of loan to get to borrow it. The most common choices are the home equity line of credit (HELOC) and the home equity loan? Which is better? It depends upon your needs. Let’s take a close look at both.
The HELOC vs. Home Equity Loan
A home equity loan may be referred to as a second mortgage. It works the same as your first mortgage. That means that it is issued for a certain borrowed amount with payments that are fixed each month. There are many pros and cons of a home equity loan
A home equity mortgage will have a fixed interest rate and they are fully amortized. This means that as you make your payment, you are paying both principal and interest. There is no negative amortization or interest only payments that do not reduce principal.
Home equity loan rates are typically slightly higher than competitive first mortgage rates. However bad credit home equity loans will carry a much higher interest rate.
On the other hand, a HELOC provides you with a line of credit like a credit card; the only difference is the line of credit is provided by the equity in your home. You may borrow up to that amount and no higher in a certain period of time – typically five or ten years. For tax purposes a HELOC loan is considered a 2nd mortgage as well.
The HELOC loan requires you to make monthly payments, which may be interest only for a certain period of time. After that, you will need to start to pay both interest and principal. In some cases, the interest rate on HELOCs is usually lower than home equity loan, but the rate is variable over time.
The Benefits of Using Home Equity
Whichever loan type you choose, the major benefit of borrowing home equity is that you can borrow the money at a low interest rate. The money is secured by your home, so the bank is able to offer you a loan at a lower interest rate. Home equity is always going to offer a much lower interest rate than an unsecured credit card.
Also, the interest on a mortgage is usually tax deductible; you will need to check with your tax professional on your particular case. If you can write of the mortgage interest, you could quite easily save hundreds or even thousands in taxes every year.
With a fixed equity loan or HELOC loan, you have a low interest way to pay for things you need or want. The most common reasons to tap home equity include:
- Home renovations
- College tuition
- Starting a business
- Investing in real estate
- Paying off high interest debt
HELOC vs Home Equity Loan?
When you are considering which loan to get, the reason you are borrowing the money is a key in your decision. If you have a big one-time expense, or you want to pay off a big chunk of debt, you may want to get a home equity loan.
That way you may pay for the expense and you will not have any open credit line available; this can tempt you to spend the money on things you don’t really need.
However, if you are going to have a steady stream of expenses, such as college tuition or a home renovation project, you may want a HELOC loan. This type of financing will let you pull out equity as needed, so you only pay interest on the money you use.
A HELOC also allows you to have that open credit line just sitting there unused for several years. So if you ever have an emergency expense and you need cash fast, you will have it at the ready. This type of situation gives many homeowners more peace of mind. You never know when you may need to have the roof replaced, or if there is a sudden medical emergency in the family.
Keep in mind that both loans have higher rates than first mortgages. A HELOC will usually have a lower initial rate than a home equity loan, but the HELOC’s payment can fluctuate, whereas the home equity loan payment is fixed.
Home equity loans do have formal closings and the associated closing costs, while HELOCs do not have a formal closing, so the initial expenses are lower.
The Bottom Line
There is no perfect answer on the HELOC vs. home equity loan question. Which you select comes down to the reason you need the money, your personal financial situation, and your risk tolerance.
People who want a lower rate and are ok with a variable rate may prefer the HELOC. But if you are ok with a higher rate and more security, a home equity loan may be better.
If you are doing home remodeling or rehabilitation and you are not exactly how much you need to borrow then a HELOC loan may be the ideal choice. Especially if you do not know when you will need the money, because with a HELOC loan, you only pay interest on the portion you access.
Remember that whichever you choose, you are putting your home on the line by signing the loan paperwork. If you don’t pay, you can lose your home. So make sure that you are borrowing the money for a good reason, and be sure that you make that payment on time each month.