Are you trying to pick the best between a home equity loan vs line of credit? If YES, here is a detailed comparison between equity loans and business line of credit.
If you decide to sell your house, you will definitely have quite a sum of money in your hands. But for the time being when you are still residing in the house, the gain you would have made from the sales of the house is still locked up and out of reach from you unless you decide to get your hands on a part of it through the use of home equity loan or home equity line of credit also known as HELOC.
Home Equity Loan Vs Line of Credit – Which is the Best?
Home equity loan and HELOC are both considered as second mortgages and are drawn on the value which a house has above and beyond what is owed on the primary mortgage.
Home equity can be seen as the amount of your home which you own out rightly. To calculate home equity, you will have to subtract the home’s current value from any liens against it, such as your mortgages. Take for instance, if your home is worth $300,000 and your still have $130,000 left on your mortgage, this means that you have $170,000 in home equity.
If you have intentions of taking up a home equity financing loan, it is very expedient that you should research all the options that are available to you. To the uninformed eye these loans may look alike, but you can end up spending more or less depending on how you plan on using the funds.
Thorough research will also help you to understand what you should be doing as well as how much you will end up paying over the duration of your loan. By weighing their pros and cons, you will be able to make a decision that is best suited for your situation.
It should be noted that even though both home equity loans and home equity line of credit make use of your home as a collateral, they differ in terms of how you access loan funds and make repayments.
What is a Home Equity Line of Credit?
A home equity line of credit refers to the difference between the amount of money that is owned in your mortgage and the actual estimate of the home’s appraised value. So before a lender gives you a home equity line of credit, an appraisal will have to be undertaken on your home in order to determine its current market value. The difference that exists will then be made available to you in form of a home equity line of credit.
A HELOC is secured by a lien on your house. Usually, you will already have a master mortgage on your house which could range from a period of 30 to 10 years and was put there when you originally bought the house.
A HELOC therefore uses the equity you have in the house which could mean that you either did not have a mortgage for a substantial part of the property when you bought it or that you have owned the house and made payments such that you have equity over and above what the mortgage balance is and as such you own a percentage of the house or by operation of property values going up you have attained a portion of equity in the property than when you bought.
In order words there is extra value in the house which allows you to borrow money against it. One way you can take care of additional financial needs like this is by using your equity in the house to simply refinance the mortgage and have one loan again and borrow some money back out against the house or you can leave the original mortgage in place and do a home equity line.
The home equity line will be dependent on an appraisal and will also hinge on your income and your ability to pay your first mortgage that is on the house and the additional amounts that you will borrow from time to time against the house.
You can have the money automatically funded to you in full so that if you should take a $40,000 HELOC you will have exactly that amount when you sign. Alternatively, you can have the line of credit established and then have cheques that you draw against it or a credit or debit card which you can use for any of your needs.
People usually make use of home equity line of credit to;
- Improve and upgrade their home
- Access a lower interest rate than a credit card if they want to make a lot of purchase or to just have extra money in the bank
- Consolidate debt
- Help bridge gap in higher education if they themselves are going to school
- Go for vacations
When you take up a HELOC, you will enter into a fixed period of time during which you can withdraw from your line of credit. This is known as the draw period. The draw period varies from lender to lender and in some cases can last up to 10 years and you are only paying back the interest during this time.
Once your draw period has come to an end, you will not be able to borrow money again. You will then enter what is known as the repayment period in which you will be required to repay the principal amount along with the accruing interest. Also, this repayment period differs from lender to lender.
A lot of HELOC’s have variable interest rates. This implies that the amount of money you pay back on a monthly basis will differ depending on if the rates go up or down.
What is a Home Equity Loan?
With home equity loan, a home owner can be able to get a fixed amount of money in one lump sum instead of a revolving credit. You will then have to pay back the loan over an agreed term. Unlike a HELOC, most home equity loans have a fixed rate and as such the interest rate will not change until you have repaid back the loan. You are also paying part of the principal alongside the interest payments until you will be able to pay back the loan in full.
Most times, home equity loans tend to attract higher interest rate when compared to HELOCS’s due to the fact that the lender gives you the security of a fixed rate.
HELOC Vs Home Equity Loan
A HELOC and a home equity loan are very similar in the sense that they both use the equity in your home as collateral in order to secure a loan. Equity in this case is the difference between what you owe in your mortgage and what your home is worth.
A home equity loan is a term loan. This means that the amount that is borrowed is paid back over the life or term of the loan. The interest rate of a term loan is also fixed and will not vary irrespective of how volatile the rates may be over the life of the loan.
This therefore implies that the monthly payment is also fixed. A home equity loan is a great option for people who have a specific purpose to borrow at a specific period of time especially if they want budget certainty.
On the other hand, a HELOC is an open ended or revolving loan. Funds can be drawn or accessed anytime they are needed by the customer in the same way a credit card may be used. The rates are variable and are usually based on the prime rate.
So as the prime rate moves up and down, the rate on the loan will also move up and down, and as a result, the payment of the loan will also move up and down. Also affecting the monthly payment is the balance on the loan. As customers draw more funds from the line and their balance increases, their monthly payments will increase and as they pay down the outstanding balance, their payment will decrease.
So Which is the Best?
Home equity loans are best when the interest rate is low because they are fixed. When the interest rate is high but are projected to come down, then you can go for a home equity line of credit instead.