For the vast majority of people “home sweet home” is their most valuable asset. Borrowing against a home can free up cash for many purposes that would otherwise be out of reach. Enter home equity loans and home equity lines of credit (HELOCs), both ways to access home equity without the homeowner having to sell. Home equity loans and HELOCs are essentially second mortgages that are secured by the home as collateral.
To calculate equity, subtract the amount you owe on your mortgage from your current property value. Generally, lenders will let you borrow up to 85% of your home equity, depending on your credit score and history, employment history, and monthly income and monthly debts. However, if you default on payments for either a home equity loan or a HELOC, the lender can foreclose on the property. That said, tapping into your home equity can be a sound strategy to raise cash for large purchases if and when you need it.
The rundown on home equity loans:
- Lump sum
- Fixed interest rate
- Conventional loan structure separated into interest and principal
- Monthly payments are predictable and don’t change.
- Monthly payments are for a set period.
- Monthly payments are made in addition to mortgage payments.
The rundown on home equity lines of credit:
- Revolving credit line, money is withdrawn as needed (like a credit card).
- Variable interest rate often begins at lower rate than home equity loans.
- Conventional loan structure separated into interest and principal or interest-only payments
- Monthly payments adjust up or down based on a benchmark interest rate.
- Rising interest rates can increase payment.
- You only pay interest on the money you withdraw, not the total credit available.
- Some lenders allow partial or full conversion to fixed rate home equity loans.
- The typical borrowing period is 10 years followed by a repayment period of 10 or 20 years.
- During the borrowing period, you have to make minimum monthly payments on the amount you owe..
- Once the borrowing period ends, you have to repay the remaining balance, like a conventional loan..
- Interest may be tax-deductible.
- You can make additional principal payments.
- You can refinance.
Which option is right for you? Home equity loans could potentially be better for people who have an upcoming one-time expense with a known cost. For example, this might include home improvement projects, a down payment on another property, wedding expenses, emergency expenses, even credit card debt consolation. Home equity loans could also benefit people who want to avoid overspending. On the other hand, HELOCs could potentially be better for people who have upcoming variable or periodic expenses and would benefit from access to a revolving line of credit. For example, this might include home improvement projects, college expenses, medical bills, long-term care expenses, or a new business venture. As with most financial planning questions, the answer to this question depends on each homeowner’s unique circumstances, so this is a great question to discuss with a financial advisor.