Homeowners who need cash may qualify to borrow against the equity in their homes. Home equity is generally defined the current value of the home minus the amount of liens against it -- like mortgage balances. If your home is worth $250,000 and your mortgage payoff amount is $125,000, you would have approximately $125,000 in home equity. When considering home equity financing, it's important to shop and compare your options.
Home Equity Loan vs Line of Credit: What's the Difference?
A home equity loan is sometimes called a second mortgage. It works in the same way as your primary (also called your first) mortgage; it's issued for a specific amount and repaid with fixed monthly payments. Home equity loans typically have fixed interest rates and are fully amortized, which means there are no "exotic" loan features such as interest only payments or negative amortization. A home equity line of credit (HELOC) provides a line of credit and allows you to draw funds up to your maximum credit line as needed. HELOCs require monthly payments, but may allow interest-only payments for a specified time. When the repayment period is up, you'll be expected to pay off any balance due on your line of credit. The way that you draw and repay funds for a line of credit is similar to the way you draw and repay funds for other revolving lines of credit, such as credit cards. Home equity lenders provide debit cards or checks to use for HELOC withdrawals.
Benefits of Home Equity Financing
The appeal of both of these loans is their interest rate, which is almost always lower than those of credit cards or unsecured bank loans. That's because your home serves as collateral for either a home equity loan or line of credit. In addition, the interest you pay on a home equity line or loan may be tax deductible. Please consult a tax advisor to find out if this applies to your circumstances. Lower interest rates on home equity loans and lines of credit may make either option a good choice for consolidating consumer debt. Consumers should review interest rates and finance charges for all accounts considered for consolidation. The goal of debt consolidation is to convert multiple payments to one payment with a lower interest rate than the interest rates of the accounts you consolidate.
Home Equity Loan or HELOC: Your Choice!
When you consider home equity loan vs line of credit, your reason for borrowing is a key factor. If you have a large one-time expense or want to consolidate a specific amount of debt, a home equity loan is your best bet. That way, you can pay for the expense and not have the temptation of available credit remaining. If you expect recurring expenses, such as payments made to contractors during home renovation, a HELOC allows you to "pay as you go." You are only charged interest on amounts drawn against your credit line and can spread out your use of a HELOC as needed rather than borrowing the full amount and paying interest on it in advance of your needs. A HELOC also allows the flexibility of having funds available without having to pay until you draw against your credit line; this can provide ready cash in case of an emergency.
Home Equity Loans vs Line of Credit: Comparing Costs
Both home equity loans and HELOCs usually carry higher interest rates than first mortgages. Home equity loans generally come with fixed rates, but adjustable rates may also be offered. While adjustable rates are often lower than fixed rates, they can change according to the terms of the home equity loan or HELOC. Home equity lines of credit almost always have adjustable rates; however, once the drawing period has ended and the repayment period begins, some of them allow the borrower to convert them to fixed-rate loans. Home equity loans require borrowers to pay for closing costs, including escrow fees, title work, a home appraisal and document recording fees. HELOCs don't require a formal closing and have lower upfront costs than home equity loans.
The Federal Trade Commission (FTC) advises that home equity loans and HELOCs are secured by your home, and either can be foreclosed according to state law. Second lienholders including home equity lenders are typically notified if you fall behind on your first mortgage. This may cause your home equity lender to advance payment to the first mortgage lender and require immediate reimbursement from you. Failure to reimburse your home equity lender can also lead to foreclosure. While home equity financing provides convenient source of cash, it can also tempt you to incur more debt than you can repay. World travel and a garage full of toys won't be worth it if you lose your home.