You know that you can borrow against the equity that you've built in your home, using the funds from home equity loans to pay for whatever you want, whether you're ready to remodel your aging kitchen or pay off high-interest-rate credit card debt. What you don't know, though, is whether it makes more sense to take out a standard home equity loan or a home equity line of credit, better known as a HELOC. Which loan product is the better choice?
What are equity loans?
Building equity is one of the main benefits of owning a home. Equity is the difference between the value of your home and the amount you still owe on your mortgage. If you owe $250,000 on your mortgage and your home is worth $375,000, you've built $125,000 in equity.
Why does equity matter? If you have it, you can take out either a home equity loan or HELOC that is based on the amount of equity you have. If you have that $125,000 in equity, you might be able to take out a loan or HELOC for up to $90,000, for example. You can then use those funds for anything, though many homeowners will use them to cover major home-improvement projects, to help cover a child's college tuition or to pay off credit card debt.
But what's the difference between a home equity loan and a HELOC?
Home equity loans are typically fixed-rate loans that come with a set repayment term. The money from these loans come in a single lump sum that you pay back with regular monthly payments, with interest, until the loan is paid off.
A HELOC is a bit different; it operates like a credit card with a credit limit based on the amount of equity in your home. A HELOC gives homeowners access to a revolving line of credit that they can draw from when needed.
With a HELOC, you'll only pay back what you borrowed. For example, if you have access to a line of credit of $90,000 and you then borrow $25,000 to remodel your kitchen, you'll only pay back that $25,000 that you borrowed.
A HELOC typically comes with two phases. First, there's your draw period, which usually lasts 10 years. During this period, you can borrow funds up to your HELOC's credit limit and make interest-only payments. You can also make principal payments on what you've borrowed if you choose.
Then there's the repayment period, which usually lasts 20 years. During this period, you can't borrow any more money, but instead you must make monthly payments to pay off whatever you borrowed during the draw period.
So, what's the smarter choice?
Unfortunately, there is no simple answer to that question. Whether a HELOC is the right choice for you depends largely on what you need money for.
If you need a specific amount of funds for an individual project or goal, such as a home renovation or paying off your credit card debt, a home equity loan might be a better choice. That's because you receive one lump sum of money that you can use to fund these expenses.
But if you want access to a source of cash that you can use whenever expenses pop up, then a HELOC might be the better choice. Maybe you plan on renovating your home, but you want to tackle a series of projects one at a time. With a HELOC, you can borrow what you need to, say, renovate your kitchen before moving on to borrow more to add a master bathroom.
The best move is to speak with your mortgage lender about whether a home equity loan or HELOC is the better choice for you.