We all have financial goals – whether it’s remodeling our homes, taking a once-in-a-lifetime vacation, or becoming debt-free. However, homeowners have a unique advantage when chasing their dreams. They can use the equity in their homes as a financial tool and lock in some of the lowest interest rates around in the process.
While your home’s equity can unlock the door to endless possibilities, one question borrowers always ask is, “Should I use a HELOC or Home Equity Loan?” While both options allow you to tap into the equity in your home, they operate differently and serve distinct purposes.
In this article, we’ll break down the differences between home equity loans and lines of credit and provide insights about which will work best for your specific needs.
What is Home Equity?
Before diving into the different loan types, it’s essential to understand how home equity works - and why it’s so beneficial to homeowners.
Home Equity = Value of Home (Current Market Value) – Amount Owed (Mortgage Balance)
For example, if your home is valued at $400,000 and you currently owe $250,000 on your mortgage, your home’s equity will be $150,000. Lenders will allow you to borrow a portion of this money through a home equity loan or line of credit.
Home equity loans are secured loans, meaning your home is used as collateral. Because of this feature, the interest rates are substantially lower than most personal loans or credit cards – a significant perk to borrowers.
How Can I Use My Home’s Equity?
One of the greatest perks of home equity loans is that you can use the money for just about anything! Homeowners can tap into their equity, borrow at affordable rates, and put the money toward any financial goal.
Some common uses include:
-
Upgrading or Repairing Their Home
-
Paying for Events (Dream Vacation or Wedding)
-
Consolidating High-Interest Debt
-
Covering Unplanned Medical Expenses
-
Starting or Expanding a Company
-
Financing Higher Education
-
Serving as a Financial Lifeline or Emergency Fund
Should I Use a Fixed Rate Home Equity Loan or HELOC?
Deciding which loan type is best for you depends on how you plan to use the funds. The two standard home equity options are:
-
Fixed Rate Home Equity Loan
-
Home Equity Line of Credit (HELOC)
Each has unique features, pricing structures, and advantages and drawbacks. To choose the right option for you, review the following characteristics of each loan type.
Features of a Fixed Rate Home Equity Loan:
-
Payout Structure:
With a home equity loan, the entire amount borrowed is given to you in one lump sum. If you borrow $40,000, that amount will be deposited into your account once you close your loan.
-
Ability to Access Additional Funds:
You cannot increase your loan amount to obtain more funds. Instead, you would have to refinance your loan and include the higher amount in your new application.
-
Interest Rates:
Traditional home equity loans typically have fixed interest rates, meaning the rate will not change throughout the life of your loan. This feature is perfect for individuals who want consistent monthly payments.
-
Payment Terms:
Because you receive the funds as a lump sum and the interest rates are fixed, home equity loan payments are the same every month. Your loan term will be determined when closing on your loan, and the payments will remain consistent throughout – like a car loan. Borrowers who want simple budgeting will find this feature to be a significant advantage. Repayment terms up to 15-years are typically available.
-
Loan Uses:
While you can use the money from a home equity loan for just about anything, the lump-sum payout and consistent payments are ideal for specific scenarios.
For example, if you were remodeling your home or putting in a pool where you know the total amount upfront, a home equity loan is the perfect solution. You can borrow exactly how much you need at once and begin paying off the loan monthly.
Features of a Home Equity Line of Credit (HELOC):
-
Payout Structure:
The most significant difference between a home equity loan and a HELOC is that HELOCs function more like a credit card. You are approved for a set limit, for example, $40,000. However, you do not have to borrow all this money at once. You can borrow only what you need, whenever you need it. Once you repay the borrowed amount, you can borrow it again throughout your draw period (typically around 10 years).
-
Ability to Access Additional Funds:
While you cannot access additional funds over your approved limit, you can borrow from your approved line of credit again once the outstanding balance is paid. This convenience is a major perk of HELOCs.
-
Interest Rates:
Unlike fixed rate home equity loans that offer fixed rates, HELOCs generally come with variable rates. Because the draw period can be up to 10 years or more, interest rates will fluctuate during that time. While rates might increase with the economy, if rates drop, you’ll automatically benefit from lower interest charges.
Many HELOC’s also offer a discounted introductory interest rate. LMFCU is currently offering a 12-month introductory rate of 2.99% Annual Percentage Rate.
-
Payment Terms:
Again, HELOCs function like a credit card. When you draw on your credit line (or spend available funds), payments will begin on the borrowed amount. Once you repay the balance, you can draw on those same funds again. You only make payments on what you spend, not your approved amount.
-
Closing Costs:
Many lenders, including LMFCU, will pay the closing costs incurred to establish your HELOC. Lenders may place limits on the amount of closing costs that are paid. Lenders also typically require the HELOC to be open for specified number of years and/or have a certain minimum or average balance for a certain number or years to avoid repayment of closing costs.
-
Loan Uses:
The flexibility of HELOCs makes them extremely popular for all kinds of uses. Many people use them for various needs at once, such as taking a vacation, home repairs, and consolidating debt. Because you can borrow, repay the amount, and borrow again – HELOCs are versatile financial tools.
Homeowners often open a HELOC to serve as a financial lifeline or emergency fund. If unexpected expenses arise, like medical bills or home repairs, they have immediate access to affordable funds. And, again, you only pay interest on what you spend – not your approved limit.
Takeaway:
Fixed Rate Home equity loans and lines of credit are extremely valuable perks for homeowners. The ability to borrow low-rate funds for any need is a financial benefit that can help move you closer to your goals without taking on high-interest loans.
Choosing the right loan depends on how you plan to use the money. If you want ongoing access to funds to complete a variety of projects or to serve as a financial lifeline, then a HELOC is the perfect solution. If you want to borrow a set dollar amount for a specific project, like a home remodel, a traditional home equity loan is a wise choice.
Both solutions provide low rates, extended terms, and higher borrowing limits – setting homeowners up for success as they progress toward their goals.
We’re Here to Help!
Home equity loans are a coveted perk of being a homeowner. They offer flexibility and affordability not found with traditional personal loans or credit cards. And the ability to use the funds for various needs makes them versatile and adaptable to your financial goals and lifestyle.
If you want to learn more about home equity loans or need help deciding which option works best for you, we’re ready to help. Please stop by our office or call 800-410-0501 to discuss loan options with an experienced Credit Union Loan Specialist.