- You can take out a home equity loan or a home equity line of credit (“HELOC") if you have equity in your home
- Home equity loans offer the ability to borrow a single lump-sum amount, which is then repaid in monthly payments
- Home equity loans usually have a fixed rate of interest for the life of the loan
- A home equity line of credit is a revolving credit line and works similar to a credit card
- HELOCs have variable interest rates; meaning the interest rate can increase over the life of the loan
A big advantage of owning a home is the ability to build equity over time. To find out how much equity you have in your home, you find the difference between your home’s current market value and how much you owe on your mortgage.
Simply put, if the value of your home is greater than the amount you owe on your home, you can often borrow a percentage of that difference. Home equity loans and home equity lines of credit are loans that are backed by a borrower’s home.
Both types of loans are often referred to as subordinate mortgage loans or second mortgage loans. This means that they are liens with a lower priority than your first mortgage. Typically, they are offered at a lower interest rate than other loans since your home is being used as collateral. However, there are major differences between home equity loans and home equity lines of credit. Knowing the differences between the two and understanding how each works can help you decide which could be the right solution for you.
What is a Home Equity Loan (HE LOAN)?
A home equity loan is a lump-sum loan that’s secured by the equity in your home. The cash supplied from the lender is offered in one upfront payment to you from the lender, which you repay in monthly installments. A home equity loan allows you to apply for the specific amount of money you need. It is a fixed-term loan contracted by a lender; meaning the interest rate and repayment term stays the same throughout the life of the loan. Home equity loans typically range from $50,000 to $500,000 and have repayment term options of 5, 10, and 15 years at fixed interest rates.
What is a Home Equity Line of Credit (HELOC)?
Similar to home equity loans, home equity lines of credit are secured by the equity in your home. The difference here is that a home equity line of credit is a revolving credit line and works similar to a credit card, but the amount of credit available to you is tied to the equity in your home. HELOCs allow you to take money out against the credit line up to a limit, which is based on the equity in your home, make payments to reduce the balance of the loan, and take money out again. HELOCs have a draw period during which you can tap into the credit line when, or if you decide you need it. Interest will only be charged on the funds drawn; therefore, the unused portion of your credit line will not accumulate interest. After the draw period ends, you will repay the remaining balance in monthly payments.
HELOCs have variable interest rates. This means the rate on the loan can increase or over its life. As you withdraw money from your HELOC, the monthly payments are determined by the unpaid principal balance and the interest rate. Payments may change based on your balance and interest rate variations.
How Can You Use Home Equity?
Borrowing against the equity in your home could free up cash for many reasons.
- Debt consolidation. Use a home equity loan or line to pay off balances you owe on higher-rate loans. This is a debt-relief choice that can manage the stress of keeping up with multiple bills and deadlines from varying companies. This could potentially improve your credit score in the process.
- College Education. College can be expensive and student loans aren’t always the lowest-interest way to finance it. You could use your home equity to pay for tuition, consolidate existing student loans, or to cover books and housing costs.
- Finance home renovations. Using home equity to make home improvements can help increase the market value of your home. What could be better than using the value in your home to increase that value?
- Vacation. If you need a little extra money to go on that vacation you’ve been dreaming of, using your home equity could be the right solution.
- Emergency expenses. It’s always a good idea to have an emergency backup when you are in need of access to cash in a pinch. If an emergency comes up, and there are costs associated, the equity in your home could help.