Q: We have a lot of equity in our home and only a few years left before our mortgage will be paid off. Unfortunately we're up to our ears in debt from our credit cards and also need to make some home repairs. We want to draw against our home equity to consolidate our debt and take care of the repairs. Should we get a home equity loan or a home equity line of credit?
A: Either type of loan would work, but each is more effective for certain purposes.
Home Equity Loans: When You Need a Lump Sum
Home equity loans, sometimes called second mortgages, are mortgages taken for a specific amount, which is delivered when the loan closes. Home equity loans can come with fixed or variable interest rates, and their payments are calculated to pay them off during their specified term. If the rate is fixed, the payments are equal for the entire life of the loan. This makes budgeting easier. A home equity loan is generally used for a one-time expense of a predetermined amount, for example, consolidating debt.
HELOCs: Pay as You Go
A HELOC, or home equity line of credit, is an open-ended loan that functions in some ways like a credit card. It can be used as needed up to your available maximum. You'll make monthly payments based on the amount you've borrowed, your loan term and your interest rate.
HELOCs have two phases-- the drawing period and the repayment period. Once your drawing period expires, you can't increase your balance anymore and must make monthly payments until the loan is repaid. For example, you might take a 15-year HELOC with a five year drawing period to cover college tuition. After (hopefully!) graduation, you'd stop tapping the credit line and focus on paying it off over the next ten years.
HELOC interest rates are almost always variable; however, some programs allow to you convert to a fixed interest rate once you have stopped drawing on your credit and have entered the repayment phase.
HELOCs and Home Improvements
You indicated that you have some home repairs to make. HELOCs can be good for paying for home improvements or repairs that take place in stages over time -- for example, if you're replacing the roof this fall and then add a deck and some landscaping next summer. If you're doing your repairs at one time, however, a home equity loan is probably a better choice.
Whichever product you choose, compare rates and fees before committing to a lender. Our network of home equity lenders can help you find your best home equity loan rates.