Home Equity Line Of Credit vs Home Equity Loan

One of the greatest things about owning a home is that you are building your net worth! Many American households take advantage of this worth and equity via a home equity line of credit (most referred as HELOC) or a home equity loan. To keep it simple, these are 2 products you want to consider applying for if you’re looking to turn your equity into accessible cash without having to sell your home. Sounds like a good deal right? Before you jump on it and call your bankers, there a lot to learn about tapping into your home’s equity.

The top reasons Americans use a HELOC or a home equity loan

Based on the research I conducted for this post, these are the top reasons for accessing the equity in your home:

  1. home improvements
  2. to make investments
  3. use equity as a student loan
  4. consolidate debt
  5. alternative funding for emergencies
  6. take advantage of low interest rates

So ask yourself the following, why do you need to tap into your equity? Do you have a specific goal in mind?

Interest rates

As of 8/20/17 and according to Bank Rate, interest rates for HELOCs are 5.54% and 5.35% for a home equity loan. I spent a few minutes searching other banks and their interest rates varied. Make sure to explore several options to find the best and most competitive interest rates in the market for this type of financial product.

How much equity do you have?

Since you’re exploring to tap into your equity, you need to start off by knowing how much equity you have (common sense). Here is the formula:

Appraised home value – Mortgage balance = Equity

If you haven’t appraised your home, use the best judgement possible to determine your estimated home value.

Estimated home value – Mortgage balance = Equity

The Differences

Home Equity Line of Credit (HELOC): this acts like a revolving line of credit, which is similar to a credit card (minus the rewards and additional benefits). You pay interest only on the amount of money that you use and you have the flexibility to pay the monthly minimum payments or more to pay down the debt faster.

At a high level, here are some things you need to know about the HELOC:

  • adjustable interest rates or fixed rates (some lenders offer fixed interest rates)
  • interest you pay is tax deductible
  • you use money as you need it
  • pay interest only on the money you use
  • flexible monthly payments

Home Equity Loan: this is a lump sum loan and you borrow this money with specific terms. Terms can range from 5 years to 30 year terms. Here is what you need to know about this type of loan:

  • the money is provide in one lump sum
  • it offers fixed interest rates
  • interest you pay is tax deductible
  • the monthly payments are fixed
  • you pay interest on the entire loan and that is already calculated into your monthly payments

How much can I borrow?

Home equity lenders have a benchmark stating that you can borrow up to 80% of the home’s appraised value. However, you’ll need to subtract the mortgage balance to determine your true equity. Then, subtract your equity from the 80% of the home’s appraised value. As an example, your home is appraised at $300,000 and your mortgage balance is $150,000. 80% of $300,000 home appraisal is $240,000. Subtract $150,000 from $240,000 and the max you can tap into with a HELOC/equity loan is $90,000. 

Very important to know

As you consider one of these 2 options, this does not eliminate your monthly mortgage payments. The monthly payments made to either a HELOC or equity loan is in addition to your mortgage. This is crucial for you to consider as you prepare your budget for this type of financial decision.

Also, this cash is given to you based on the equity and the home is used as collateral. There is risk that comes with using these financial products because if you default on repaying the loan or credit line you can experience a foreclosure. I say this not to freak you out, but only to make you aware of the risk.

Recommendation

My personal recommendation is to select the HELOC because offers the most flexibility and you only use the amount of money that is needed, as opposed to a lump sum loan. The downside is that you may pay a little bit of more interest, but that is the cost of the flexibility I like to have. Either way, both types of loans are great products, you just have to select the one that best fits your needs.

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