ome equity loans and lines of credit are a great way to leverage the equity in your home to borrow money for home improvements or a variety of other uses. But how do you decide which loan is best for you?
Let’s Take a Closer Look at Equity Options
There are two types of home equity loans: term, or closed-end loans, and lines of credit. Both are sometimes referred to as second mortgages, because they're secured by your property, just like your original (first) mortgage. But unlike your first mortgage, home equity loans and lines of credit are usually for a shorter term than first mortgages, typically 5 to 15 years.1
Home Equity Loan
A home equity loan, sometimes called a term loan, is a one-time lump sum that is paid off over a set amount of time, with a fixed interest rate and the same payments each month. Once you get the money, you cannot borrow further from the loan.1
Home Equity Line of Credit (HELOC)
A home equity line of credit works more like a credit card. You are allowed to borrow up to a certain amount for the life of the loan -- a time limit set by the lender. During that time you can withdraw money as you need it. As you pay off the principal, your credit revolves and you can use it again. For instance, if you have a $10,000 line of credit, borrow $5,000, then pay back $3,000 toward the principal, you’ll have $8,000 in available credit. The revolving nature of this loan gives you more flexibility than a fixed-rate home equity loan.1
HELOCs have a variable interest rate that fluctuates over the life of the loan. Payments will vary depending on the interest rate and how much credit you have used. Some HELOCs may even include an option to lock in a portion of your balance at a fixed rate, much like a home equity loan.
When the life span of a line of credit has expired everything must be paid off. A lender may or may not allow a renewal,1 and, like your first mortgage, you will pay off the loan or line of credit when you sell the house.
You can also take advantage of potential cost savings with these types of loans compared to other alternatives such as credit cards and personal loans because some or all of the paid interest on a second mortgage may be tax deductible. Consult your tax advisor regarding deductibility.
What's Best for You?
So, which type of equity loan is best for you? Ask yourself:1
• When do I need the money?
• For how long do I need the money? Is it for a short-term or long-term purpose?
• How long do I need to pay it off?
• How big a monthly payment can I handle?
Ask your lender:1
• How long is the term of the closed-end loan?
• What is the life span of a line of credit?
• How large a line of credit do I qualify for?
• Is my line of credit renewable when the life of the loan expires?
• What are the interest rates?
• Do I have to use my credit line right away? If you're opening a credit line for future or emergency needs, you'll want one that doesn't require a minimum draw at closing.
If you need a definite sum of money quickly, and you have no plans to borrow again, then a home equity loan with a defined term and fixed monthly payments may be the best way to go. But, if you anticipate having recurring expenses over a long period of time – such as school tuition or a long-term remodeling project – then a home equity line will probably best suit your needs.
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This information is for educational and illustrative purposes only.