Homeownership provides shelter, stability and a sense of pride, and it can also serve as a valuable financial asset. If you find yourself in need of extra funds, tapping into your home equity can be an attractive option. Today, homeowners who want to access their equity without refinancing their mortgage and giving up a low rate on their current loan have two common options: a home equity line of credit or a home equity loan. In this post, we will explore the ins and outs of these mortgage strategies to help you decide if one is right for you.
Understanding Home Equity
First, it’s important to know what home equity means. Home equity refers to the portion of your property that you truly own, calculated by subtracting your current mortgage balance from your home’s current market value. For example, if your home is valued at $400,000 and you owe $200,000 on your mortgage, your equity would be $200,000.
Typically, a well-qualified homeowner can borrow up to about 90% of their home’s value. Therefore, if you had $200,000 in equity in a $400,000 home, you might expect to qualify to take out up to $160,000 in equity as cash. This limit, known as a loan-to-value limit, is subject to change and may vary based on factors such as your credit score and property details.
Home Equity Line of Credit (HELOC)
A HELOC is a revolving line of credit that allows you to borrow against the equity in your home. It functions similarly to a credit card, offering you a set credit limit that you can draw from as needed. Here are the key features of a HELOC:
- Revolving Line of Credit: One of the main advantages of a HELOC is the flexibility it offers. You can withdraw funds up to your credit limit at any time during the draw period, which typically spans several years. You will only pay interest on the funds you have withdrawn.
- Variable Interest Rate: Like a credit card, a HELOC has a variable interest rate, meaning the rate can fluctuate over time based on market conditions and the HELOC terms. A HELOC rate typically begins below a comparable home equity loan rate, allowing for potential savings. However, there is always the risk that your rate could increase, causing your interest charges to rise.
- Repayment Terms: During the draw period, you may only be required to make interest payments, which helps keep your initial payments down. Once the draw period ends, the loan enters a repayment phase with a predetermined term of up to 30 years. At this point, you’ll need to repay both the principal and interest, either in fixed monthly installments or a lump sum payment. Most HELOCs have no penalties for repaying early.
Home Equity Loan (HELOAN)
Also known as a second mortgage, a home equity loan involves borrowing a lump sum of money against your home equity. Unlike a HELOC, a home equity loan provides a one-time payout and typically offers a fixed interest rate and predetermined repayment terms. Here are the key features of a HELOAN:
- Lump Sum Payout: With a home equity loan, you receive the funds as a lump sum upfront, and there is no option to withdraw additional funds.
- Fixed Interest Rate: Home equity loans typically offer fixed interest rates, providing stability and predictability in your monthly payments. This means you can budget and plan your finances with confidence, knowing that your principal and interest payments will remain unchanged over the life of your loan.
- Repayment Terms: Like a regular mortgage, monthly payments begin as soon as you obtain your home equity loan, with the predetermined repayment period typically ranging from 5 to 30 years. Some HELOANs have penalties for repaying early.
Popular Uses for Home Equity Funds
The funds you receive from your home equity can be spent on anything without restriction. Many homeowners use their funds for one or more of these purposes:
- Home repairs and renovations
- Debt consolidation
- College tuition
- Emergency expenses
- Large purchases
Deciding on a HELOC or a HELOAN
Which method of tapping your home equity you choose depends on your personal needs and preferences. If you want access to a flexible line of credit for ongoing or unpredictable expenses, and you’re willing to accept some risk with a variable interest rate, a HELOC may be right for you. If you need a lump sum for a home renovation, debt consolidation or other set expense, and you want the predictability of a fixed rate, a HELOAN may be right for you.
Whichever option you choose, it’s important to understand the added expenses that come with your borrowed funds. Your monthly HELOC or HELOAN payments will be in addition to the payments on your primary mortgage, and upfront closing costs may also be required.
Be aware that the state where your home is located may have restrictions on if, when and how you can take cash out of your home.
If you’re interested in converting some of your equity into cash, a mortgage consultation is a recommended first step. This can show you how much cash you can expect to take out, what programs are available to you and how your options compare. To request a free mortgage consultation, please get in touch today.