Borrowing against the equity build up in your home’s mortgage is a great way to have access to funds you won’t otherwise have. When you need money for home improvement, a little renovation, or maybe to replace an expensive appliance, considering to get a HELOC or a home equity loan would be the smart thing to do rather than put everything on your credit card. The thing is, you need to be sure that you understand what is the difference between the two to ensure you’ll decide on the best option for your needs.
What then, is a Home Equity Loan?
Equity is the value between the difference of your property’s worth and what you still owe on it via mortgage. If you’ve been paying your mortgage on time, then you probably have already built a sizable equity.
To tap into that equity for paying off debt, going on vacation, paying for much needed improvements, or maybe paying for college, you have the option to go for either HELOC (home equity line of credit) or home equity loan. You might be thinking that they work the same way, being that they sound nearly the same, but they don’t. This is why understanding the difference between the two is crucial for you to make the best decision depending on your circumstances.
Introduction to Home Equity Loans
Technically speaking, there are two types of home equity loans (also called second mortgage) namely, the close-ended term loans and the much more forgiving lines of credit.
The possible value that you can borrow on a HELOC or a home equity loan depends on your property’s current value minus any current loans. Lenders will get the loan-to-loan value by adding your second and first mortgage together.
Your maximum borrowing limit will differ between a HELOC and a home equity loan. A home equity loan allows you to borrow up to 85% of your equity whereas a HELOC allows you to borrow up to 65%. There are other technicalities that can raise the amount you can borrow but that’s for another article.
Home Equity Loan VS. HELOC
A home equity loan or second mortgage gives you a lump sum cash out when approved by a lender. This means you cannot borrow more money until your loan is paid off. More so, it comes with scheduled payments with a fixed interest rate.
A HELOC works like a revolving line of credit in the sense that you can borrow up to a specified value by the lender. You can withdraw funds when needed, pay it off so you can use it again almost like a credit card; however, a HELOC has a variable interest rate while a credit card often has a fixed interest rate.
Why Choose a HELOC or a Home Equity Loan
Both the home equity loan and HELOC has lower interest rates compared to unsecured bank loans or credit card. It should be noted though, that the payments you have to make with a HELOC will vary because it has varying interest rates and that those rates will only apply to the amount you’ve withdrawn. In the case of a home equity loan, you’ll know what your monthly payments will be because it has a payment schedule plus charges a fixed interest rate on the total loan amount.