What’s the Difference Between a Home Equity Loan and a Home Equity Line of Credit?
If you are a homeowner and in need of some fast cash, you should consider using your home’s equity. It has been building up since you moved in and started making your monthly mortgage payments. Homes also typically appreciate in value over the years, and that built-up profit adds to the equity and can be tapped into either at the point of sale when you decide to sell your home or earlier, while you are still living there by accessing the equity. This can be done by opening either a home equity loan or a home equity line of credit (HELOC). Using your built-up equity in your home allows you to get cash quickly and at a lower interest rate than other avenues, such as a personal loan.
We’ve mentioned two ways to access your home’s equity, and you may be wondering what the difference is between a home equity loan and a line of credit. Below we discuss the ins and outs of home loans to help you discover which option would be the best choice for you.
What Is a Home Equity Loan?
A home equity loan allows you to borrow against the profit that has built up in your home over the course of living there. Home equity loans are a second mortgage on your home and must be paid back in full like your first mortgage. A home equity loan provides you with a lump sum of cash up front to use for one-time expenses, large purchases, and major projects, such as home repairs or college tuition. Home equity loans are typically issued with a fixed interest rate.
What Is a Home Equity Line of Credit (HELOC)?
Both home equity loans and HELOCs offer the ability to tap into your home’s built-up equity, but they differ in how you access the money. Whereas home equity loans are distributed all at once, HELOCs operate more like credit cards, with a draw period and a repayment period. You draw from the approved loan amount as you need it and only pay interest on the amount you borrow. This saves you from needing to pay interest on the full loan amount if you don’t end up using all of the money. You also have the option to repay the balance and borrow that money again during the draw period. HELOCs generally have a variable interest rate, at least during the draw period.
Fixed Rate vs. Variable Rate of Interest
As we’ve mentioned, one of the key differences between home equity loans and HELOCs is a fixed versus variable interest rate. Fixed interest rates remain the same throughout the life of the loan while variable interest rates rise and fall based on the market. This can sometimes be a determining factor when homeowners are deciding between a home equity loan or a home equity line of credit.
A variable interest rate can mean your monthly payments also increase and decrease with the market. While some borrowers like the flexibility and chance that their rates could go down, others are uncomfortable with the possibility that the rates could go up and prefer the stability of a fixed rate.
Having a fixed interest rate also makes budgeting much easier, as you will know exactly how much your monthly payments will be until the loan is repaid. The positive of a variable interest rate is that, typically, the home equity lines of credit are offered at a lower starting interest rate and then increase over time, making your payments lower at first. Which is better for you ultimately depends on your unique finances and tolerance.
How Do I Know How Much Equity I Have in My Home?
Your home’s equity is defined as the current market value minus the dollar amount still owed on your mortgage or any other liens. Industry standards typically allow borrowers with a great financial track record to borrow up to 85 percent of their home’s calculated equity. You can find your home’s available equity by using a free online home equity loan calculator to see how much you may be able to borrow against your home’s available equity.
To further determine how much a lender may let you borrow, calculate your loan-to-value ratio by dividing your outstanding home loans by the current market value of your home. If the total is a higher number, your lender may be more hesitant to let you borrow a large percentage of your available equity.
When to Use Your Home’s Equity
Ultimately, how you use your home equity funds is up to you. Some good uses for tapping into your home’s equity include:
- Home improvement projects, which can also increase its market value
- Consolidating high-interest credit cards into one lower-interest payment, thus saving money in the long run
- College tuition, as the interest rate on your home loan may be less than a student loan
- Emergency costs, such as medical expenses or unexpected home repairs
Your home is typically the biggest financial asset at your disposal to use for collateral if you need a large sum of cash. Using your home’s equity, however, does come with some risk since you are putting up your home as collateral. This means the lender can and will foreclose on your home if you are unable to pay back your loan. So, remember to use your home’s equity responsibly.
Which Home Equity Loan Is Best for Me?
Before deciding if a home equity loan or a home equity line of credit is right for your financial needs, it’s important to consider certain factors, such as how much money you actually need for your current situation, and what the interest rates will be for each loan type. You also need to look at how much your monthly payments will be and if you are able to fit those into your current monthly financial budget in order to pay off your second mortgage and not risk losing your home. If you have any questions, don’t be afraid to reach out to a trusted lender that can help you make the right decision.
If you are in northeast Wisconsin and ready to discuss your home loan options, contact Capital Credit Union to speak with one of our financial experts. We’ll look at the difference between a home equity loan and a line of credit in your specific situation and help you choose the best option.
Meta: Need cash fast? Learn how a home equity loan and line of credit vary in access, interest rates, and repayment. Find the best choice for your financial needs.
