Home Improvement Loans: HELOC or Home Loan?

If you're considering home improvement loans, you have several options, and each offers advantages and disadvantages. Home equity financing is popular because it's one of the cheaper alternatives for funding home improvement projects. Home equity loans are secured by your property, which lessens the risk to lenders, but increases it to you – you can lose your home if you don't pay your home equity lender. Home equity financing comes in two flavors – Home Equity Lines of Credit (HELOCs), which are revolving accounts and function similarly to credit cards, and home equity loans, which deliver a lump sum at closing and are repaid in monthly installments. Here's what you need to consider when choosing between them.

Home Equity Lines of Credit Offer Greater Flexibility

HELOCs are popular because they are the most flexible source. HELOCs allow you to borrow the exact amount you need, exactly when you need it. You can repay and reuse it again and again.

It's appropriate, for example, if you're completing a series of smaller projects over time. You might use your HELOC to purchase materials at a building supply store in September, rent tile cutting equipment in November and pay a landscaper in the spring. Many equity lines of credit come with a debit card to facilitate purchases for repairs, new construction or appliances.

Another advantage of HELOCs is that they cost very little to set up and can be funded quickly. Your property may be appraised or the lender may just use an automated valuation model (AVM) to estimate your home's value.

HELOCs have two main disadvantages. First, your lender can reduce your credit line or even close your account if your credit rating or home value drops. If that happens when your kitchen renovation is in the demolition phase, you'd be in bad shape. The other disadvantage is that HELOC interest rates are variable, which can make budgeting your renovation more difficult.

Home Equity Loans Deliver Stability

Home equity loans, aka second mortgages, typically allow you to borrow against 85 to 90 percent of your property value. They are more costly to set up then HELOCs, involving appraisal expenses, title and escrow charges and recording fees. When you close on your loan, you'll get the entire amount in a lump sum. They typically come with fixed interest rates, although adjustable loans are available.

Home equity loans are appropriate when you need a large amount of money upfront – for example, to pay a contractor for a home addition. They are less flexible than HELOCs but contain fewer surprises. You have a fixed interest rate and a fixed payment, which makes budgeting easier. In addition, your lender can't change your loan amount or terms once you have closed your loan.

HELOCs and Home Equity Loans Are Mortgages

Home improvement loans are excellent tools for getting you the cash you need for repairs or renovations, but they are not without risk. It's important to remember that both of these financing options are mortgages. Unlike credit cards or unsecured personal loans, they are secured by your property. This means your house could be repossessed and sold if you don't repay the loan and end up in foreclosure. Choosing the right loan can help you avoid the temptation to overspend and keep you from paying unnecessary fees.

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