Our goal here at Credible Operations, Inc., NMLS 1681276, hereinafter referred to as “Credible”, is to provide you with the tools and confidence you need to improve your finances. Although we promote the products of our lender partners who compensate us for our services, all opinions are ours.
Equity is the difference between your mortgage debt and the value of your home. You get your home equity by paying the principal balance on your mortgage and when the value of your home increases.
Home equity loans and lines of credit are common ways to leverage equity. Each has its own pros and cons, and there are risks. Here’s a quick guide to help you decide which option is best for your needs.
What is a home equity loan?
A home equity loan, also known as a second mortgage, allows you to keep your existing mortgage but take out a second new home equity loan in a one-off event. You pay off the loan in equal monthly installments over a specified term.
You can usually borrow up to 85% of your home equity through a home equity loan. For example, if your home is currently worth $ 400,000 and your current mortgage is $ 300,000, you have $ 100,000 of home equity in the home and you can borrow up to $ 85,000 (85% of $ 100,000) with a home loan. …
You can inquire about current mortgage rates and information on another product for raising capital – cash-flow refinancing – by visiting Credible…
What is a line of credit secured by home equity?
A home equity line of credit or HELOC is similar to a home equity loan in the sense that you keep your existing mortgage and borrow against the equity of your home. However, HELOC is a revolving loan that allows you to re-borrow funds within the credit limit for a period known as the “pick-up period”. You then repay the loan over another term, known as the “repayment period.”
Most lenders limit the amount you can get under the HELOC to 85% of the appraised value of your home, minus the amount you owe on your existing mortgage. If your home is worth $ 400,000 and your current mortgage is $ 300,000, you can get a line of credit up to $ 40,000 ($ 400,000 x 85% = $ 340,000 – $ 300,000 = $ 40,000).
Home equity loan versus HELOC: what’s the difference?
Both loans secured by real estate and home equity lines of credit allow you to borrow against the value of your home, but there are a few key differences.
Fixed interest rates versus variable interest rates
Interest rates on real estate loans are usually fixed, so if interest rates rise over the life of the loan, your payments will not be affected.
HELOCs usually have variable interest rates. When interest rates rise, your Interest rate HELOCand therefore your monthly payment also increases.
Withdrawal: Lump sum or withdrawal as needed
With a home equity loan, you borrow a specified amount in a lump sum and repay the loan in regular monthly installments over a specified term.
HELOC gives you more flexibility in choosing the loan amount and time. Like a credit card, you have a line of credit that you can reuse during the draw period, and you only pay interest on the amount currently being used.
Repayment: fixed payment versus variable monthly payment
FROM loan secured by equity with a fixed interest rate, your monthly payment is based on the full loan amount. The loan term usually ranges from five to 30 years. During this time, you make equal monthly payments that include both principal and interest.
On the other hand, HELOC payments can change from month to month. Since most HELOCs have variable rates, your interest rate can fluctuate over the life of the loan. Also, your payment is based on the amount you are currently using. For example, if you have a $ 20,000 HELOC but only withdraw $ 10,000, you will only pay interest on the $ 10,000 currently in use.
Advantages and Disadvantages of Home Loans
Like any loan, loans secured by real estate have their own advantages and disadvantages. Before taking out a home equity loan, consider the following:
Pros of home loans
Fixed interest rates: One of the advantages of a home equity loan is a fixed interest rate. Even if interest rates rise, your monthly payment will not increase because your interest rate will remain the same.
Flexible use of funds: Lenders usually allow borrowers to use funds for any purpose. Once approved, you can use the home equity loan to pay home improvement projects, debt consolidation, purchase of investments, payment of education expenses and other uses.
Potential Tax Credits: When you use a home equity loan to improve the property that secures the loan, interest can be deducted from the tax base. Keep in mind that you must list a benefit deduction, and your deduction is limited to interest on debt of up to $ 750,000, including your first mortgage.
Cons of home loans
Two Mortgage Payments: If you haven’t already paid off your first mortgage, getting a home equity loan will give you a second mortgage payment that you will manipulate every month.
Higher interest rate than HELOC: you will probably pay a premium to have a stable rate. Rates for mortgaged real estate loans are generally higher than the starting rates available for HELOC.
Closing costs: Like other home loans, home equity loans come with closing costs and commissions that average between 2% and 5% of the loan amount. Your lender can include these in your loan so that you don’t have to pay cash when closing the deal, but they add to the total cost of borrowing.
You can read about closing costs in Crediblewhere you can also find out about current mortgage interest rates.
Advantages and disadvantages of HELOC
Lines of credit secured by home equity also have their advantages and disadvantages. Before using HELOC, consider the following pros and cons:
Pros of HELOC
Lower starting interest rate: HELOCs have lower interest rates than a credit card or personal loan, and they also usually offer lower starting interest rates than home equity loans. However, keep in mind that the HELOC annual interest rate may rise if interest rates rise.
Borrowing and Repayment Flexibility: You can have a $ 30,000 HELOC, but this month you only need $ 5,000 to replace your oven. Next month, you may need $ 10,000 to repair your roof. With HELOC, you can use your line of credit as needed and repay even if you keep borrowing. Each time you use your line of credit, your payment is dependent on the amount outstanding.
Potential Credit Benefits: The combination of loan types in your credit report represents a factor in determining your credit rating… Adding HELOC to your existing loan use can expand the range of loan types you use and have a positive effect on your credit rating.
Cons of HELOC
Fixed Costs: HELOCs carry the same initial closing costs as home loans, but lenders may also charge a fee for the life of the line of credit. According to FTCthese recurring costs may include an annual membership or participation fee, as well as a transaction fee each time you borrow money.
Variable interest rate: s adjustable speed HELOC, your rate may go up or down depending on market fluctuations. Even if your HELOC offers a low starting rate, depending on economic factors, you may face higher rates when you get to the maturity period.
Risk of cost overruns: managing a HELOC can take some self-discipline as it is very easy to access and spend with a HELOC. If you’re not careful, you can run into overspending and face huge interest payments when the repayment period begins.
Home equity loan or HELOC: which is better?
Which home equity product is best for you – a loan or a line of credit – depends on your needs and specific situation…
If you need a large amount of money for a one-off event and want a stable flat rate, then a home equity loan can help. However, if you want to leverage your equity in smaller chunks over several years and don’t mind some uncertainty in your interest rate, HELOC might be the option for you.
When to use equity, and when not
Whether you opt for a HELOC or a home equity loan, avoid using your home equity to pay for things that are unnecessary, such as a vacation or buying a boat. Both home loans and HELOC use your home as collateral, so if you run into financial problems and are unable to make monthly payments, you risk losing your home.
Likewise, it is a good idea to avoid using home equity to cover purchases that are depreciating faster than you can repay the loan. For example, if you are using a 30-year loan or line of credit to buy a car, you may need to replace the car in 5-10 years. However, you can pay off the debt that was used to buy it for several more years.
What You Should Know About Equity
You may want to use home equity for many reasons, but before applying for a home equity loan or HELOC, consider how long you plan to stay in your home. If you can’t pay off the loan or line of credit before the sale date, you can walk away with less profit or even zero profit on the sale after paying off the mortgage and closing costs.
When choosing between a secured real estate loan and HELOC, be sure to search different lenders to compare interest rates and commissions. Ask a lot of questions to make sure you are getting the right financial product at the best possible price.
Credible cannot help you find a HELOC or home equity loan, but it can help you compare refinancing offers with cash payments – another option for using equity.