Deidre Woollard: There's often debate around using home equity loans versus HELOCs,
home equity lines of credit. Which one is right for you? Let's break down the pros, cons,
and best use cases for each. I'm Deidre Woollard, editor of Millionacres, and today we are talking
about home equity loans and HELOCs.
There's often confusion between home equity
loans versus HELOCs, or home equity lines of credit. Both let you tap into your home
equity for cash, but they function quite differently. Before we go into that, let's talk first about home equity.
Put simply, home equity is the share of a
home or property that you actually own. To calculate how much equity you have, you start
with your home's value, and then you subtract your home's remaining mortgage balance.
For example, if your home appraises for $280,000 and your current loan balance is $150,000,
you have $130,000 in equity. Putting that as a percentage, you have around a 46% equity
stake in your home. Financial products like home equity loans and HELOCs allow you to
borrow against this equity up to a certain point, typically 80% to 85% for most lenders.
You can use the funds to pay for home renovations, medical bills, tuition costs, or any other
expenses you might have coming your way. You can also use home equity loan products to
consolidate and pay off higher-interest debts like credit cards and personal loans.
You can think of HELOCs a bit like a credit card. They act as a line of credit, and you
can use the money whenever you'd like. A HELOC can be an alternative to a credit card, which
could carry a double-digit annual percentage rate. You can withdraw funds over an extended
period of time called a draw period. This can last up to 10 years. During this time,
you'll typically make interest-only payments on only the amount of money you've taken out,
not your full credit line. After the draw period is up, you'll enter the repayment period,
in which you start to repay the money borrowed plus interest. This period usually lasts from
10 to 20 years. HELOCs typically come with a variable interest rate, meaning the rate
will fluctuate over time. You'll usually get a low promotional rate at the beginning of
the loan, and the rate will increase as you get into the repayment period. If you're considering
a HELOC with a variable rate, it's important to consider any caps your lender might put in place.
A home equity loan is like a traditional mortgage
loan in that you're given a lump sum all at once, rather than a line of credit you can
draw from at will. Home equity loans act a second mortgages, meaning you'll need to make
two mortgage payments each month. You then pay the balance back month over month across
your loan term, which typically ranges from five to 30 years. Because home equity loans
can give you access to large amounts of cash at once, they're often a smart choice if you
have a big expense you're dealing with.
The biggest downside of using a home equity
product is, you're potentially putting your home at risk. Since home equity products use
your property as collateral, you could find yourself in danger of foreclosure if you fall
behind on payments. There are also other costs to consider. Home equity products come with
closing costs and fees. On HELOCs, you might even see fees each time you make a withdrawal.
These can add up over time, especially if you expect to make several transactions over time.
Choosing between home equity loans versus
HELOCs comes down to how much money you need, how predictable your expenses are, and your
current financial limitations. The first thing you want to think about is what you intend
to use the money for. Generally speaking, a home equity loan is going to be best if
you have a large, predictable, one-time expense to cover, like a new roof, a major car repair,
or consolidating other debts. If your costs are less predictable or you expect them to
recur over time, like tuition bills or medical treatments, a HELOC may be a better option,
as it allows you to pull funds as needed across an extended period of time.
Next, think about your financial situation. How predictable is your income? Do you need
consistent payments that you can easily budget for, or can you afford more fluctuation?
If you need consistency, a home equity loan is your best bet. These come with fixed interest
rates and predictable payments for the entire loan term. If you can deal with some ebb and
flow, a HELOC could be an option. Just make sure you're prepared for a big jump in the
size of your payments once your withdrawal period ends.
If you're set on tapping your home equity, HELOCs and home equity loans aren't your only option.
You might also consider a cash-out refinance. This allows you to replace your
existing mortgage loan balance with a new, larger loan. You then take the difference
between the two in cash, which you can use toward home improvements or any other expense,
just like you would with a HELOC or a home equity loan. The main difference here is,
you're not adding a second payment. Instead, you're replacing your existing loan payment
with a new one. It might be higher or lower or the same as your old one; it all depends
on the loan term, interest rates, and total loan balance. Regardless, cash-out refinancing
can be a smart choice because it keeps you to one mortgage payment per month and gives
you a large lump sum to use however you see fit. However, refinances also come with closing
costs and other upfront fees.
Tapping into your home equity is not a decision
to be made lightly. You probably don't want to use your home equity to finance the luxury items.
In the pre-recession years, some people used home equity loans to finance fancy cars,
vacations, or expensive clothing, and that is not a sound financial strategy.
Also, if you're using home equity loan products to meet basic expenses like groceries, clothing,
utilities, and phone bills, that's a sign you have a deeper problem. It's time to take
a serious look at your budget and figure out what's happening there and what you can trim.
In general, home equity products are best used for things that will benefit you in the
long run, like paying off other high-interest debts or loans, or making improvements that
increase the value of your home. For more on home equity loans, home equity
lines of credit, and refinancing, please visit the real estate financing hub on millionacres.com.
You can find the link for that in the video description. If you want more info on
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