By Paul Mulligan, Senior Vice President
One of the benefits of owning a home is the ability to use built up equity to finance other cash needs with a Home Equity Loan or a HELOC. Some of these uses carry more value than others – and some carry more risk. Because of that, potential borrowers should do their due diligence and consider all aspects of these loan products before making a decision to put up their homes as collateral. Click HERE for 7 Things to Consider with Home Equity Loans.
That includes understanding different loan alternatives and how they may benefit your needs for cash, like the difference between a home equity loan and a home equity line of credit (HELOC). While they are similar and both use the home as collateral, they are designed differently and can end up with different total cost of loan figures.
Home Equity Loan
A home equity loan provides borrowers a single, lump sum of cash that must be paid back over a specified period of time at an agreed interest rate. It’s similar to a first mortgage in that payments are a known constant and go towards both interest and principal. With home equity loans, you are paying off the full amount of the loan plus interest.
Home Equity Line of Credit (HELOC)
A HELOC is a revolving line of credit with a predetermined limit. Think of a HELOC almost like a home equity credit card that gives borrowers access to a cash reserve they can draw upon for whatever needs they may have. The line of credit remains active for a specified period – up to 10 years, depending on the lender. While the line of credit remains open, borrowers pay back interest; once the draw period is over, payments typically increase and include both interest (only on the amount withdrawn) and principal (the amount withdrawn) payments.
Lenders may offer customers different options for accessing funds, and they may have minimum withdrawal amount policies or require a minimum outstanding balance. Make sure you are aware of all details of your loan before signing the paperwork.
Which is better?
This is a question each borrower has to answer based on his or her circumstances. Home equity loans tend to be useful for large projects – like home remodels – that require a large payment at one time, or for situations where the amount to be borrowed is known.
HELOCs are good options for borrowers who need access to smaller amounts of cash over a period of time – such as for a number of smaller projects over the course of several years, or when the total amount required may not be known.
Home equity loans typically have fixed rates, which means payments will be the same for the duration of the repayment period. HELOCs usually are variable rate loans based on Prime Rate or some other standard index plus a margin. HELOCs may come with a lower introductory rate that increases – along with monthly payments – once the introductory period expires. Check with your lender for current rates.
Both HELOCs and home equity loans typically include closing costs that may also include additional fees for appraisals, insurance, loan processing, attorney fees, and more. Be sure to ask your financial specialist what fees you can expect with either type of loan and whether any additional fees may apply under certain conditions, such as early repayment, or with each withdrawal from a HELOC.
The bottom line is that both home equity loans and HELOCs allow homeowners to tap into the equity in their homes to finance other needs. What those needs are and whether either of these two is a good option is something a loan expert at your financial institution can help determine. Regardless of what option you choose, be sure to shop your loan needs around to get the best terms, but be sure to ask as many questions as possible to determine the total cost to you over the loan period. Also make sure repaying the loan doesn’t exceed your monthly budget. If you are unable to pay back the loan, you’ll be putting your home at risk. But, with the right planning and advice from a financial expert, home equity loans and HELOCs are both great options for taking advantage of the equity you’ve built up in your home.
If you’re considering a second mortgage, The Milford Bank has several loan products that may be ideally suited to your needs. Contact our loan experts today to discuss your specific needs and make sure you have all the information you need to make an informed decision.