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Tap the equity you’ve built in your home for major or ongoing expenses.
Chances are, your home is your biggest financial asset. As you pay down your mortgage, you build equity that you can then put to work through a home equity loan or HELOC. Both loans use your home as collateral, which can be a powerful motivator for timely repayments. But how you access your cash depends on the loan you choose.
How does a home equity loan differ from a line of credit?
Both loans offer unrestricted financing backed by the equity in your home. And how much you can borrow typically tops out at 80% to 95% of your home equity, depending on your credit score.
But they differ in how you access your equity and pay back what you borrow.
A home equity loan allows you to tap into the equity of your home to borrow a lump sum of cash. Also known as HELOANs, home equity loans typically have a fixed interest rate and schedule. This means you’ll pay a set amount each month for the life of the loan — usually five to 15 years. Depending on your lender, you may be able to get an adjustable rate loan.
Because you’re taking out a second loan against your home, home equity loans are often called second mortgages. And you’ll need to repay your existing mortgage while also repaying the home equity loan.
A fixed rate makes for reliable repayment amounts, which can be easier to factor into your budget. But the tradeoff is that the rates tend to be higher than HELOCs.
A HELOC is a lot like a credit card. Rather than loaning you a lump sum to repay over time, a HELOC authorizes access to a set line of credit. In most cases, a HELOC allows you to borrow up to 80% of your home’s equity.
You can borrow against that amount as many times as you need to during a draw period of five to 10 years, depending on your loan. You pay interest only on the amount you draw. And if you’re able, you can pay extra to contribute toward the principal of your borrowed amount.
HELOCs come with variable interest rates that rise and fall as the market fluctuates — which means your monthly payment can go up or down too. Some lenders let you convert a portion of your balance to a fixed rate, while others limit how many times the interest rate can change during the loan, called a lifetime cap.
When the draw period is over, you enter the loan’s repayment period, which typically lasts 10 to 25 years. In that time, you can’t take out any new funds, focusing instead on repaying what you’ve borrowed.
Home equity loan vs line of credit comparison table
Home equity loans
At least 15% equity in home
43% to 50% debt-to-income ratio
620 or higher credit score
Ability to repay based on income, assets, expenses and credit history
At least 20% equity in home
43% to 50% debt-to-income ratio
620 or higher credit score; 720+ for the strongest rates
Ability to repay based on income, assets, monthly expenses and credit history
Variable, though some lenders allow conversion to a fixed rate
Access to funds
Withdraw money as you need it, paying interest on the amount you draw
Use of funds
Typically 5 to 15 years
Draw period: Typically 5 to 10 years Repayment period: Typically 10 to 25 years
What are the benefits of a home equity loan and a line of credit?
Each loan allows you to access a major asset — your home — and use the cash to pay for anything you need.
Home equity loans
Fixed interest rate. Your payments stay steady, even if the Federal Reserve raises interest rates.
Set payment schedule. Along with predetermined rates, makes for easier budgeting.
Lump-sum payment. Use the money for college, medical care or whatever you’d like.
Looser eligibility. To apply, you need at least 15% equity in your home and a credit score of 620.
Flexible borrowing. Just like a credit card, withdraw the cash when you need it.
Delayed interest. You don’t pay interest until you access the money. Even then, it’s only on what you borrow.
Low or no closing costs. Some lenders cover the application and appraisal fees — but read the fine print of your loan.
Quick approvals. If you need cash now, a HELOC is fairly easy to obtain.
Fund access. Withdraw money through a check or card linked to the HELOC.
What are the drawbacks of a home equity loan and line of credit?
With both loans, the biggest drawback is that your home is on the line. If you don’t meet the requirements set out in your agreement, your lender can seize your property as payment.
Home equity loans
Multiple monthly payments. It’s a second mortgage, which means you’ll need to keep track of two loans and make two separate repayments.
Closing costs. You face the same closing costs as a traditional mortgage, though you may be able to roll them into your loan.
Higher interest rates. The security of a fixed rate results in weaker rates than a HELOC.
Risk of property depreciation. If home values in your area decline, you could end up owing more than your home is worth.
Unpredictable interest rates. HELOCs are pegged to the prime rate. As rates rise, so do your monthly payments.
Strict credit requirements. You’ll need a score of at least 620 to qualify and 720 for the strongest rates.
Harder to manage. You must be disciplined to avoid paying a lot for principal and interest during the repayment period.
Additional fees. You may pay annual membership, maintenance or transaction fees for each withdrawal. Most lenders also charge fees for late or missed payments, which can increase the amount you owe.
Which option is better suited for me?
When you’re deciding between a home equity loan and a HELOC, think about why you want to borrow money.
If your expenses are expected to increase over time — like with medical bills and college tuition — you might want to look into a HELOC. You’ll have the flexibility to access funds as you need them, and you’ll pay interest only on the amount you withdraw.
If you need cash, you may be able to use your home as collateral with a home equity loan or line of credit. Home equity loans are best for financing a project with a fixed cost, while HELOCs give you flexible access to your money over time.
Borrowing against the equity in your home is not a decision to be taken lightly. Before committing, compare home loan lenders and weigh the benefits against any drawbacks.
Frequently asked questions
Yes, as long as you use your home equity loan or line of credit to buy, build or substantially improve your home. This is one of the major changes brought in by the new tax laws of 2018.
So, if you use your loan or HELOC to add a second story to your home, the interest is most likely deductible. If you use the money to pay for your college tuition, you won’t be able to claim the interest you pay as a tax deduction.
To figure out how much equity you’ve built up in your home, subtract the balance left on your mortgage from the current value of your home.
Say your home is worth $400,000 and you have a mortgage balance of $250,000. Subtracting your balance from the home’s worth results in $150,000 in equity.
Not sure what your property is worth? Compare the recent sale of similar properties in your area or hire a professional real estate appraiser.
It depends on your lender, though most let you borrow up to 85% of the current value of your home. Typically, lenders set a limit based on your loan-to-value ratio, credit score, income and debts.
Yes. If you pay off your line of credit before the repayment period is over, your lender provides the option to close to account or keep it open for future withdrawals.
The first way is to make regular, timely payments on your loan.
The second is through price appreciation. The more your home increases in value, the more equity you’ll have.
Katia is a freelance writer from sunny Sydney, Australia. Her writing — and curiosity — has taken her around the world, and she now calls chaotic, creative New York home. She navigates insurance and finance for Finder, so you can splash your cash smartly (and be a pro when the subject pops up at dinner parties).
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