Strapped for cash? Borrowing against your home’s equity could free up funds for all kinds of expenses. Discover the ins and outs of home equity financing, and see whether this approach is right for you.
Home Equity Loans versus HELOCs
Home equity financing is a type of secured lending that uses your home as collateral. Lenders determine how much you can borrow based on your financial record and how much equity you have in your home, or the difference between what you owe on the house and its current market value. Lenders like Dominion Energy Credit Union offer two major choices:
This type of second mortgage usually has a fixed interest rate, giving borrowers predictable monthly payments for the loan’s duration. Some financial institutions may even lower the rate in return for setting up automatic payments. Financing is delivered in a lump sum, and typically repayment periods range from 10 to 15 years.
Although not as predictable as a home equity loan, a HELOC offers a more flexible alternative. Rather than delivering cash in a lump sum, HELOCs grant a specific amount of credit to be used during a set time period. Borrowers then withdraw funds up to the maximum approved amount as needed via a special checkbook, credit card, debit card or online. Interest is owed only on the amount actually withdrawn.
HELOC interest rates are generally variable, which means payments can fluctuate depending on current interest rates and the balance owed.
Both options offer low interest rates, and in most cases the interest you pay is tax deductible. The upfront fees are similar to those on your first mortgage, such as the cost of the loan application, home appraisal and title search, but many lenders will waive closing costs.
There really isn’t a clear winner when comparing home equity loans and HELOCs. The choice ultimately depends on the purpose of the financing and your unique situation.
If you’ve got a one-time expense, such as remodeling your kitchen or debt consolidation, a home equity loan may be your better choice. Since you receive all the money upfront, you can begin your project and start paying the loan back right away. This is also the best option for those on a fixed income or who just prefer predictable monthly expenses.
HELOCs, on the other hand, may make more sense for long-term variable expenses, such as ongoing home improvements or paying college tuition. HELOCs work particularly well when the need for cash is unpredictable, giving borrowers funds at a moment’s notice.
Because HELOCs are variable-rate loans, you should factor in the possibility that interest rates could go up, causing your payments to rise with them. Also, since both types of loan use your home as collateral, if you default, you run the risk of the lender foreclosing on your house.
Either form of home equity financing can be a powerful tool to help you with major expenses. Used correctly, they can help enhance your quality of life, whether by improving your home, paying for an education or making your debt load more manageable.
Roberta Pescow, NerdWallet