Home Equity Loan vs. Home Equity Line of Credit: Which Is Right for You?
Borrowing money against the value of your house can be a smart way to finance a wedding or handle an emergency that might otherwise drain your finances. If you have significant equity in your home (subtract how much you still owe on your mortgage from your home’s current market value; that’s how much equity you have), you can use that value as collateral to get a low interest rate and borrow a good bit of money.
There are two ways to approach borrowing against the value of your home. A home equity loan, often called a second mortgage, is a straightforward, lump-sum loan. You apply for a certain amount of money, you get it all at once, and you pay it back over time.
A home equity line of credit, known as a HELOC, is a line of credit extended to a homeowner that uses the borrower’s home as collateral. You’ll be approved for a certain amount of money to be used and repaid within a certain period of time. During that time, you “charge” only what you actually use—perfect for long-term projects like a long remodel where you need to use a little bit of money at a time and you’re not sure what the total will be.
Home Equity Loan Pros and Cons
Home equity loans typically offer very low interest rates. It’s easy to work a home equity loan into your budget because interest rates don’t fluctuate over the life of the loan, so your payments will always remain the same.
Still, it’s important not to overextend yourself. Because you’re using your home as the collateral, if you default on the loan, you could lose your home. And if you decide to sell your house, you’ll have to pay off your home equity loan at the time that you sell.
HELOC Pros and Cons
A HELOC is perfect when you don’t know exactly how much you’ll need because you’re not borrowing and paying interest on more money than you actually use. That makes it perfect for paying contractors during a long remodel or paying for a college education semester by semester. Some HELOCs allow interest-only payments for a period of time, making them perfect for emergencies. The minimum monthly payment only includes the interest on the money borrowed, rather than the principal plus the interest. At the end of the loan any outstanding balance is due.
Your HELOC payments will vary according to how much of your credit line you’ve used and possibly according to changing interest rates. Make sure you understand when and how your monthly payments will change and what may be due at the loan’s maturity. You could also be required to take an initial lump sum when you set up your HELOC.
It can be tempting to use a HELOC like a long-term loan or to afford things that are a little beyond your means. Remember that just a like a home equity loan, a HELOC uses your home as collateral. If you default on the loan, you could lose your home.
The Right Home Equity Loan for You
Different types of home equity loans and HELOCs may best fit your financial needs. For example, PenFed has an Adjustable Rate HELOC program that has an interest rate with the potential to adjust periodically every few years. It’s a great fit for short-term needs—saving you money with an initially low interest rate. Investigate the full range of home equity loan options at PenFed.