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HelpOnce you have built up equity in your home, you have the privilege of borrowing against the value of your house through either a home equity line of credit (often called a HELOC) or a home equity loan. In effect, both are essentially a second mortgage on your home. You can usually receive equity access for up to 80 percent of your home’s appraised value, minus whatever you owe on your first mortgage.
A HELOC is a form of revolving credit similar to a credit card. It allows you to draw funds, up to a predetermined limit, whenever you need money. There is generally a minimum payment due each month, with the option to pay off as much of the line as you want. With a loan, you receive a lump sum of money and have a fixed monthly payment that you pay over a predetermined time period. In each case, the amount you can borrow is based on factors such as your income, credit, debts, the value of your home, how much you still owe on your first mortgage.
Benefits
The appeal of both of these types of loans is their interest rates, which are almost always lower than those of credit cards or conventional bank loans because they are secured against your home. In addition, the interest you pay on a home equity line or loan is often tax deductible.
Which is Best for You?
Generally, a HELOC is a good choice to meet ongoing cash needs, such as college tuition payments or medical bills. A loan is more suitable when you need money for a large, one-time purpose, such as buying a car or a major renovation.
Comparing the Costs
Both HELOCs and loans usually carry a higher interest rate than that of a first mortgage. With a loan, you may choose either an adjustable interest rate that fluctuates according to variations in the prime rate, or opt for a fixed rate. A fixed rate enables you to easily budget a set payment monthly without worrying about increasing costs should interest rates rise. With a loan, there may also be closing costs.
A HELOC usually carries a lower initial interest rate than a loan, but its rate fluctuates according to the prime rate, so there is more interest rate risk. Unlike a loan, where your monthly payments are fixed, a HELOC enables you to borrow funds as needed and repay as little as interest only each month. In addition, there are generally no closing costs when you open a HELOC.
Keep in mind that your home serves as the collateral for both a HELOC and a loan. If a HELOC’s easy access to cash tempts you to run up more debt than you can repay, or if you fail to make your payments, you risk losing your house.
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