When it comes to tapping into your home’s equity, you’ve got two popular options: a Home Equity Line of Credit (HELOC) or a Home Equity Loan. Both can provide you with the funds you need, but they work in different ways. Let’s break down the differences so you can choose the one that’s right for you.
What is a Home Equity Line of Credit (HELOC)?
A home equity line of credit (HELOC) is when the bank approves you for a certain amount of money that you can access when you need it. Think of it like a credit card. You have the ability to borrow or draw money on an ongoing basis from an available maximum amount. And you don’t have to pay anything unless you use it.
A HELOC is flexible in that you can borrow, repay, and borrow again during the draw period, which usually lasts 5-10 years. However, interest rates are variable and can change over time. Therefore, your monthly payments might vary. During the draw period, you often pay only interest. Afterward, you’ll pay both principal and interest.
Having this type of credit line is ideal for projects like home renovations where you might need different amounts of money at different times.
What is a Home Equity Loan?
On the other hand, a home equity loan is an actual loan with a fixed interest rate, secured by your home’s equity. This type of load is ideal for a large, one-time expenses like consolidating debt, paying for college, or a major home improvement project.
Let’s say you wanted to do some home improvements, and you needed one hundred thousand dollars. Once approved by the bank, you’ll receive the money you are borrowing in a lump sum payment. You are then required to pay it back like you would with any other type of loan.
Interest rates for home equity loans and home equity lines of credit are based on the prime lending rate published in the Wall Street Journal.
Benefits of a Home Equity Line of Credit
With our homeowner clients, we recommend that they open a line of credit. Even if you think you don’t need one, it’s still a great tool to have in your tool belt. The benefit is that you’re not charged for it unless you use it. The line of credit is especially important to have access to when you’re heading into your retirement years.
Think about cash flow during retirement. You’ll be drawing on your 401(k) plan for money. And most of the time that should sustain you. But what if you encounter a large, unexpected expense? If you take additional money out of your 401(k), you’ll be taxed for the whole amount. So, even if you’re in good financial shape, it’s never a bad idea to have another source of available cash.
Here are some more examples.
- What if an unexpected opportunity arises? Let’s say you have the chance to purchase a piece property quickly. If you already have the home equity line of credit in place, you can use that money and make the purchase quickly!
- Now, let’s say you lost your job. If you have the line of credit in place, it will give you peace of mind for cash flow during an uncertain time. And remember, it’s unlikely you’ll get approved for the line of credit while you’re unemployed because the bank knows you might not be able to pay the loan if you have no job.
Which one is right for you?
Consider a HELOC if you need ongoing access to funds and can handle variable payments. A Home Equity Loan is a better choice if you prefer a lump sum with predictable monthly payments.
Both a HELOC or a Home Equity Loan have pros and cons. When choosing between the two, consider your financial situation and what makes you feel more comfortable. Always consult with a financial advisor to help you make the best decision for your needs. Reach out to us and we’ll guide you through the process!
For more information whether you should choose a HELOC or Home Equity Loan, listen to our podcast:
