Home equity financing is popular because it is affordable – cheaper than almost any other financing available to consumers. You can choose between home equity loans and home equity lines of credit, or HELOCs. Which is better? That depends on the use to which you will put the money.
What Is a Home Equity Loan?
So what is a home equity loan?
- You receive a lump sum when you close on your mortgage and pay it off over time.
- Your rate is usually fixed, although some are variable. Some variable rate loans can be converted to fixed rate loans at one or more times during their term.
- Closing costs are generally low compared to first mortgages.
- Home equity loans are often your best choice when you need money to consolidate debt or make big-ticket purchases like second homes or boats.
- Home equity loan amounts cannot be reduced after closing even if your home value drops.
What Is a Home Equity Line of Credit?
HELOCs are different in many respects. As the name implies, you get a line of credit instead of a lump sum. You can, up to your credit limit, borrow as much as you want, when you want.
- You only borrow what you need.
- Your rate is variable.
- Your payment depends on your rate and loan balance.
- HELOCs are often the right choice when you need money periodically – for college tuition, for example, or to provide extra cash flow for a business or fund an ongoing home improvement project.
- HELOC limits can be reduced by the lender after closing if your home value declines.
How Much Do Home Equity Loans Cost?
Home equity loans and HELOCs are also called second mortgages because in the event of a foreclosure, it’s the first mortgage lender that gets repaid from the sale of the property. Only if there are any proceeds left after paying off the first mortgage lender will the home equity lender be paid. This makes these loans riskier than first mortgages, so their interest rates are generally a slightly higher
However, the fees for home equity loans tend to be lower – sometimes just a few hundred dollars.
Home Equity Credit: The Keys to Good Borrowing
The Federal Trade Commission (FTC) warns that home equity financing can harm your financial well being if undertaken thoughtlessly. To make sure you get a deal that benefits you:
- Shop around for lenders. You can start on this Website.
- Don't skip reading the documents you receive. You’re responsible for what you sign.
- If you're unclear on anything, ask your lender, broker or an independent professional to explain.
- Be especially sure that you understand the interest rate, features like balloon payments, and the loan fees and other costs.
- If you go for a variable-rate home equity loan or HELOC, find out how often interest rates can change and by how much.
- If your HELOC has a rate cap, make sure you'll be able to continue borrowing no matter how high general interest rates rise above that cap.
- Feel free to negotiate with your lender if you don't like something in its offer.
- Don't take credit or other insurance unless you need it.
- Walk away if you suspect you're dealing with a shark.
There are some great home equity credit lenders out there. Just make sure you find one of them.