Are you in the process of remodeling your home? Or maybe you're looking to consolidate your debt? If that's the case, you might want to explore the option of opening a home equity line of credit (HELOC) or applying for a home equity loan. Both of these options utilize the value of your home as collateral and can be instrumental in achieving your home improvement or financial objectives.
“Most home equity loans and HELOCs allow you to borrow up to 85 percent of the value of your home, minus your outstanding mortgage balance, and they typically have low interest rates and fair terms, since you’re using your home as collateral for the loan,” according to Bankrate writer Ellen Chang.
HELOCs and home equity loans both rely on your home's equity to determine eligibility, but they have distinct differences.
HELOC
Opening a HELOC is similar to having a credit card. Once approved, you have access to a predetermined amount of money, just like a credit limit, and you can draw from it whenever needed. A HELOC consists of two parts: the draw period and the repayment period. During the draw period, you can access the funds, while the repayment period is when you start paying back what you borrowed. According to Amy Fontinelle, a writer at Investopedia, the draw period for a HELOC can last for 10 years, followed by a 20-year repayment period. It's important to note that during the draw period, you'll need to make interest payments, which can vary as the rates are adjustable. These payments are generally small but increase significantly once the draw period ends and the repayment period begins, as you're then responsible for repaying the principal amount you borrowed along with the interest.
“HELOCs can be useful as a home improvement loan since they allow you the flexibility to borrow as much or as little as you need,” according to Fontinelle. “If it turns out that you need more money, you can get it from your line of credit — assuming there’s still availability — without having to re-apply for another mortgage loan.”
Home Equity Loan
A home equity loan offers the advantage of predictable payments with a fixed interest rate, acting like a second mortgage. This means that your monthly payments remain the same, which is particularly beneficial if you have a strict budget to adhere to. If you have big projects planned or need to cover a one-time expense, a home equity loan can be an excellent choice. As mentioned by NerdWallet writer Holden Lewis, it provides a lump-sum equity draw and a set time limit, ensuring stability and convenience in your financial planning.
“But remember: that home equity loan payment will be in addition to your usual mortgage payment,” Lewis warns.
It's important to be aware that a potential drawback of taking out a home equity loan is the possibility of property values in your area declining. This could have an impact on your loan, potentially causing you to owe more than the appraised value of your home, as pointed out by Fontinelle. In the unfortunate event that you are unable to make the loan payments and it goes into default, there is a risk of losing your home, Fontinelle cautions.
Before making a decision between a HELOC or a home equity loan, it is crucial to have a clear understanding of their purpose and consider your financial health. Both options have the potential to bring you closer to achieving your goals, but it is essential to be diligent, practical, and strategic in your money management.