Using your equity as a financial resource
Many homeowners use the equity in their home as a financial resource, typically to pay major expenses such as home renovations, medical bills and to consolidate high-interest debt. Your home equity increases as you pay off your mortgage or if the value of your home increases. The two primary methods of borrowing money against your equity include a home equity loan and a home equity line of credit (HELOC).
Both types of loans use the equity in your home as collateral. That means that if you default on the payments, the lender is legally entitled to foreclose on your house. Despite that similarity, there are significant differences between a home equity loan and a HELOC, according to NerdWallet. Homeowners would do well to study these differences carefully when deciding if and how to use their home equity.
Home equity loans
A home equity loan, commonly known as a second mortgage, works like a typical loan. You receive a lump sum payment that you repay by making regular payments, usually once a month. The interest rate is fixed, meaning that it doesn't change over the course of the loan regardless of changes in economic conditions. The term of a home equity loan is usually between five and 20 years, which is considerably shorter than the 30-year term of a conventional mortgage. Lenders often limit the amount of a home equity loan to 80 percent of your equity.
The most common reason for taking out a home equity loan is to make a major home repair or renovation, such as adding a new room or remodeling an existing one. Homeowners also use this type of loan for debt consolidation, especially for credit cards with high interest rates. Because home equity loans have a fixed interest rate, they may be preferable to a variable-rate HELOC when consolidating debt. Greg McBride, the chief financial analyst at Bankrate, reports that the HELOC has replaced the home equity loan as the dominant product in many markets and that some major lenders may not even offer home equity loans any longer.
HELOCs
WIth a traditional HELOC, a borrower can draw against it for an extended period of time, typically about 10 years. This feature allows homeowners to borrow money for recurring expenses that are difficult to predict. For example, a major home renovation often consists of multiple projects of varying costs. A homeowner using a HELOC can pay these expenses without needing to know the exact costs in advance. You can repay the amount you borrowed through a HELOC by making the minimum monthly payment or by making a lump-sum payment.
A Figure Home Equity Line is slightly different than a traditional HELOC. With a Figure HELOC, you’ll get all of the money once you close, and the interest rate is fixed1navigates to numbered disclaimer. Figure’s HELOC also allows you to borrow again once you’ve paid back a portion of the principle you owe, just like a traditional HELOC.
Terms
Monthly payments for a HELOC and home equity loan are generally similar. The interest rates for a HELOC tend to be slightly higher than for a home equity loan, but the term for a HELOC is usually longer. While the interest rate for a HELOC is typically variable, some lenders are offering a fixed-rate option, which can provide you with peace of mind knowing the rate won’t increase. Both types of loans can have closing costs and other fees, which typically range from 2-6% of your home’s value. The interest you pay on both types of loans is tax-deductible, provided you use the funds to improve the home that you’re using as collateral.
Summary
A home equity loan is usually the best choice for one-time expenses of a known amount, such as a specific home improvement project or debt consolidation. On the other hand, a HELOC is typically better for paying expenses that occur over time, including general home improvement and education. HELOCs are also more useful for unexpected events like medical expenses.
