Access the equity in your home – without selling it. That’s the essence of a home equity loan (HEL) or home equity lines of credit (HELOC): two popular solutions to consolidating debt. If you would like to simplify your finances and pay a lower interest rate, then securing either financial product with your place of residence may be your best option.
Whether you take out a HEL or a HELOC, you may draw as much equity from your home as you currently have in it. You can still draw equity if you’re paying off a mortgage as well. Either type of product also charges interest. Because both are secured by your home, their interest rates are typically lower than those of most credit cards.
Aside from that, the two products function quite differently. As a loan, a HEL pays out a lump sum of money that you will gradually pay back, much like a mortgage. Conversely, as a line of credit, a HELOC functions more like a credit card: it allows you to draw money as needed, and then repay it at regular intervals.
When should you open a HEL instead of a HELOC, or vice versa? Some better understanding of their differences will help you select the better option for your unique financial needs.
Home Equity Lines of Credit Advantages
Smaller debt. Would you like to borrow smaller amounts of money to pay for day-to-day necessities? A HELOC’s similarity to a traditional credit card makes it easy. Most lenders will allow you to borrow up to 80% of your current equity in your home on a HELOC.
Adjustable interest rate. When you open a HELOC, you will be assigned a lower interest rate than if you had taken out a HEL instead. Unlike a HEL, a HELOC’s interest rate is adjustable. If the rate decreases over time, you will benefit from even lower payments.
Home Equity Lines of Credit Disadvantages
Risk of foreclosure. A HELOC’s similarity to a credit card doesn’t end with its convenience. It is possible to borrow more money than you’re able to repay, which can end in your lender foreclosing on the same asset you used to secure the line of credit: your home.
Adjustable interest rate. An adjustable interest rate works both ways. It may increase instead of decreasing, which would mean higher monthly payments. Some borrowers don’t care for a HELOC’s inherent unpredictability, as it can complicate long-term financial planning.
Home Equity Loan Advantages
Large sum. A HEL is what’s known as a “lump sum equity draw.” It provides one large payment instead of multiple smaller ones over set or irregular intervals. As such, it can instantly cover the costs of life’s larger setbacks, such as legal fees or medical bills.
Fixed interest rate. If you’re apprehensive about taking on debt that you could wind up paying higher interest on, then a HEL can give you greater peace of mind. Its fixed interest rate will let you know exactly how much you owe and will ultimately pay back.
Home Equity Loan Disadvantages
Risk of foreclosure. A HEL typically comes with a relatively low interest rate because it is secured by your home. As with a HELOC, that gives the lender the option of foreclosing if you fail to repay on its terms.
Underwater mortgage. A HEL functions similarly to a second mortgage. Like all mortgages, a HEL carries the risk of winding up underwater, in which case you would effectively owe more than your house is actually worth.
When Is a Home Equity Line of Credit Better Than a Home Equity Loan?
Do you have irregular expenses, inconsistent expenses, or both? Do you want to keep a line of credit immediately available for emergency expenses? Do you not mind if your interest rate changes over time? Then a HELOC is probably better suited to your needs than a HEL.
When Is a Home Equity Loan Better Than a Home Equity Line of Credit?
Do you need a large amount of money, and know exactly how much? Do you want to consolidate debt without opening another line of credit? Or do you want the predictability that can only come from a fixed interest rate? Then a HEL is probably better suited to your needs than a HELOC.
Do you need a second mortgage in Minnesota? Then we encourage you to contact Community First Bank, or visit one of our branches in Sebeka or Menahga today. We’re here to make sure you understand the terms of your upcoming loan, as well as secure the best terms available.