If you’re in need of funds for home repairs, renovations, or paying down high-interest debt, you may have considered a home equity loan or a home equity line of credit. While both of these financial options allow you to borrow against the equity of your home, they each come with their own set of rules and benefits. To help you decide which is right for your needs, consider these points:
Understanding your home equity
Your home equity is the amount of your home that you own outright. For example, if you have a $250,000 home, and you have $100,000 left on your mortgage, then you have $150,000 in home equity. When you borrow against your home equity, your home is used as collateral.
Hal Bundrick of Nerdwallet considers home renovations to be the best reason to tap into your home equity. These renovations will ultimately boost the value of your home, allowing you to recoup your investment.
Home Equity Line of Credit
A home equity line of credit is a revolving loan, meaning it functions like a credit card. Your financial institution will determine a maximum loan amount, and you can draw funds from it as needed. Each month, you’ll make payments based on how much you’ve taken out —not the total credit limit. Some agreements may require you to maintain a minimum amount of debt or have minimum withdrawal amounts.
Most HELOCs will have two phases — the draw period, where you can withdraw money, and the repayment period, during which you pay back the principal amount and interest. Most HELOCs have a variable interest rate, which means your rates could go up or down. However, Nerdwallet.com explains some financial institutions may offer low promotional rates, which will increase once the introductory period ends.
According to Greg McBride, the Chief Financial Analyst at Bankrate, a home equity line of credit is ideal for home improvement projects that will take place in stages, or for college tuition payments, or similar expenses that will be incurred over time.
Home Equity Loan
A home equity loan, also called a second mortgage, gives you a lump sum at a fixed interest rate. If interest rates rise or fall during the term of the loan, your interest rate won’t be impacted. Therefore, it’s easier to budget for a home equity loan. However, this security means home equity loans often come with a higher interest rate than HELOCs.
The typical home equity loan has a term of five to 20 years, with a limit of 80 percent of your home’s equity. During this time, you’ll pay down the principal alongside the interest until the loan is repaid in full.
McBride explains home equity loans are also useful for large home renovation projects. However, many borrowers use the lump sum to consolidate high-interest credit card debt.
Which option is right for you? It depends on your budget, how much you need, and how you intend to spend the money. For a more in-depth, personalized look at your financial options, speak with an advisor at your local financial institution.