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Choosing Between a Home Equity Loan or Line of Credit

In need of some cash to fund a large purchase or other expense? A home equity loan or home equity line of credit (HELOC) can be a great source of extra funds. Both loans allow you to borrow money based on the equity in your home. It’s important that you select the right loan for your unique needs. How do you determine which option is better for you? Read on to explore the difference.

What is home equity you may ask? Simply put, it’s the current market value of your home minus the outstanding balances of all mortgages and other loans against your home. You should carefully consider the pros and cons of both options before applying for a loan. Your first consideration should be why you want to borrow the money. That will be a determining factor in which loan is most appropriate.


Home Equity Loan

A home equity loan lets you borrow a lump sum of money and pay it back over a fixed term at a fixed interest rate. It’s sometimes referred to as a second mortgage. The amount you can borrow will depend on the lender. Many lenders will allow you to borrow up to 80 or 85 percent of the available equity in your home. To calculate your home equity, you need to take the current appraised value of your home and subtract everything you still owe. This includes any and all liens on your home. A home equity loan is ideal if you are incurring a large expense for one particular item or project, such as a kitchen remodel, a wedding, a big medical expense or even paying off large balances on high-interest credit cards. The fixed interest rate means your monthly payment will be predetermined and will remain the same each month for the life of the loan.  Even if interest rates fluctuate, your fixed rate is locked in and will never change. If the predictability of fixed monthly payments appeals to you and works best for your budget, then a home equity loan may be your best option.


Home Equity Line of Credit

A HELOC is more of a revolving credit line, similar to a credit card. You have a certain amount of funds that are available for you to draw on an as needed basis over a pre-determined term. The term of a HELOC is fixed, but the rate is adjustable. Although a HELOC’s lower, variable interest rate can be enticing, you need to remember that the rate will fluctuate over time and can go up. The monthly payment may change over time and it may actually cost you more over the life of the loan than a fixed rate. Or, it might not. It’s a gamble with an adjustable rate loan. A home equity line of credit works well if you know you will need to borrow smaller amounts over a longer period of time, such as paying educational expenses when your child is attending college or doing multiple home improvement projects over time. On a HELOC, the borrower doesn’t have to make any payments until he or she actually starts drawing on the money. It’s handy to have if you know you have major expenses coming up that may be drawn out over a longer period. With a home equity line of credit, you can repay principal anytime during the draw period. You can continue to use available funds and even re-borrow it again as you pay it down. After your draw period you enter a repayment period, where you will have a minimum monthly payment to pay off your outstanding balance.


Beware, your home is collateral!

Home equity can be a great asset when used responsibly. If you’ve racked up a lot of high interest credit card debt, borrowing against the equity in your home may be a good option for consolidating it into a lower interest payment and paying it off. Just remember, your house is used for collateral for both home equity loans and HELOCs. If you don’t make your payments, a lender could foreclose and seize your property. You need to be sure you have the financial ability to make your payments before you put your home on the line.  A final thought regarding a HELOC as compared to a home equity loan, the temptation of that line of credit may be too much for frivolous spenders to handle. There’s nothing worse than getting a home equity line of credit to pay for your child’s education and then finding as the bills are coming in, you’ve already depleted most of your line on a vacation. It’s important to be disciplined with a HELOC.


Are home equity loans and HELOCs tax deductible?

 Traditionally, the interest on home equity loans and HELOCs has been tax deductible. Last year’s changes to the tax laws changed that. In some cases, such as when you are using the funds to buy, build or substantially improve your home, interest on home equity loans is still tax deductible. It’s best to speak with your tax consultant to determine if, or how much interest you can deduct.


Shopping for a home equity loan or HELOC

Whether you’re planning a major home remodel, looking to consolidate debt or planning on paying for your child’s college expenses, a home equity loan or line of credit may be a great solution. First step when shopping around, as mentioned above, determine which loan is right for you. Members of Spirit Financial Credit Union can consult with one of our lenders to learn the type of loan that fits your needs and how much you are eligible to borrow. Some borrowers may not be comfortable with the variable interest rate of a home equity line of credit. They may prefer working the certainty of a home equity loan payment into their monthly budget. Others may like the idea of a line of credit to use as needed. Which type of borrower are you?

Be sure to shop around and compare APRs, terms, and related costs to find the best deal. All fees should be taken into consideration when making your decision. There may be an application fee and closing costs may include a home appraisal, title search and more. So when comparing loans, be sure to ask a lender about all fees involved so there are no surprises during closing. You will also want to consider the amount you will be eligible to borrow. Different lenders may have different formulas to determine that amount.


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