Borrowing against home equity is a common strategy for homeowners that may need money for a home project, emergency car repair or even a tuition payment. If you have a history of on-time mortgage payments, a home equity loan or home equity line of credit (HELOC) can help you tap your equity for cash.
But which is best for you? While the two are similar, determining whether a home equity loan vs HELOC is right depends on a number of factors.
Let's take a closer look at how the two compare and the benefits and common uses for each.
Home equity loans
A home equity loan works similarly to other types of installments. That is, you apply for a certain amount, are given a lump sum and then repay the principal and interest on that amount over the course of the loan term. Typically, home equity loans feature fixed rates, but some lenders offer adjustable-rate options.
With a home equity loan, your home acts as collateral to secure the loan. The amount you can borrow depends largely on your level of home equity and other considerations.
Advantages to home equity loans include:
- Predictable monthly payments over the loan term.
- Tax-deductible interest if funds are reinvested in the home.
- Lower interest rates than other types of consumer loans.
When is a home equity loan the better option?
Personal circumstances will always dictate whether a home equity loan vs HELOC is better, but there are a couple of ways to narrow the decision. For example, if you need to meet a large upfront cost or investment (like for a kitchen remodel) the lump sum of a home equity loan may be best. Fixed interest rates lead to repayments that are easier to budget for, which may be ideal for some borrowers.
HELOCs
A HELOC works more like a credit card rather than a personal loan. If approved, you will be extended a revolving credit line that you can draw on; as you repay, your available credit is replenished.
HELOCs have phases: the draw period and the repayment period. The draw period typically lasts 10 years, and you can draw from your credit line up the limit as often as you'd like during this time. The repayment period is when principal and interest must be repaid. Most HELOCs feature a variable interest rate, although fixed rates are available on some.
Benefits include:
- Only pay interest on what you draw (as opposed to the whole home equity loan amount).
- Potentially lower borrowing costs if rates trend lower.
- Potential tax-deductible interest if reinvested into the home.
When is a HELOC the better option?
Like with home equity loans, HELOCs are popular because they can be used for a number of purposes. HELOCs can be used to consolidate high-interest debt, pay for higher education or make home improvements. Your needs may be best suited by a HELOC if you expect to have variable costs over the near term.
Other points to keep in mind
While home equity loans and HELOCs are distinctly different products, the qualification process for each is largely the same. It all begins with calculating your home equity. This is roughly the current value of your home minus what you still owe on your mortgage. However, be aware you may only be allowed to access up to 80 - 85% of that value.
The interest rate and terms you are offered will also depend on your debt-to-income ratio, credit score and relationship with the lender.
Interested in learning more about home equity loans and HELOCs? Contact Comerica Bank today to get more details on our products and services.
