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One of the benefits of homeownership is the value or equity you acquire in your home as you pay off your mortgage. Even if you still owe money on your home, you may be eligible for an equity loan or home equity line of credit (HELOC) that borrows against the value in your home. These are often used to fund major purchases such as a child’s education, medical bills or remodeling projects, although you can use the money for just about any reason.
Using a home equity line of credit vs. equity loans
Both equity loans and home equity lines of credit borrow against the value of your home. The main difference between the two is how the money is disbursed. With a HELOC, you are approved to borrow “up to” a maximum amount in the form of a credit line. You can borrow from this line with special checks and you may pay it back and continue to borrow against it during the draw period. You are not required to use the full amount of the line of credit. With equity loans, the funds are disbursed in a lump sum and principal and interest payments start right away.
HELOCs are often used for financing multiple repairs, making ongoing purchases, such as supplies for a remodeling project, or paying a contractor. You could also apply your funds toward the down payment of a car and to pay for your children’s braces. Loans are often used when you have a large renovation project that will need one upfront payment.
Repaying HELOCs and equity loans
HELOC payments are interest-only on what you borrow until the end of the draw period, generally about five or ten years, after which you’ll start making fully amortized payments, which means they contain both principal and interest. Usually the repayment period will be a 10 to 30 year term, although some home equity lines of credit require repayment in full at the end of the draw period. With home equity loans, you’ll receive your funds in a one-time lump sum. You’ll begin paying this back immediately with fully amortized, fixed, monthly payments. For both options, you can still use the funds in any way you choose.
Which should you choose?
HELOCs are best suited for those that have an ongoing cash need, such as college tuition. Equity loans are more suited for one time cash needs, such as purchasing a vacation property or adding a home addition. Keep in mind that if you sell your home, you may be required to pay back your HELOC or equity loans immediately, and you may not be allowed to rent your home under the terms of the contract.
What are the interest rates on HELOCs and equity loans?
A home equity line of credit operates on an adjustable rate. The rate can go up or down as the Wall Street Journal Prime Lending Rate moves up or down. Many lenders will set their interest rate based on this rate plus or minus a margin of a few percentage points. In contrast, home equity loans generally have a fixed interest rate. In either case, your credit score and the equity in your home, as well as the loan size you are applying for, can affect the interest rate you are quoted. You’ll want to read over the terms and conditions carefully before making a decision. Some HELOCs offer a low introductory rate for the first six months or year, while others will allow you to convert from a variable interest rate to a fixed rate loan. Comparing home equity loan rates and shopping around for the best offer is a good idea. Not only will the annual percentage rate (APR) change from lender to lender, but you may also see a difference in associated costs and fees.
Choosing your lender
Home equity loans and home equity lines of credit are both great borrowing options. Do your research ahead of time and discuss all fees and interest rates associated with potential equity loans and HELOCs, as well as repayment schedules. Compare lenders before you make your final decision to ensure that you are getting the best home loan available.
Sponsored content was created and provided by RBS Citizens Financial Group.