If you’re a homeowner looking to leverage the equity you've built in your property to fund home renovations, consolidate debt or cover unexpected expenses, a home equity loan or home equity line of credit (HELOC) may offer you a flexible and affordable borrowing option. But what exactly are these two options, and how do they work?
In this comprehensive guide, we'll delve into what home equity loans and HELOCs are, how they work, their primary benefits and drawbacks and help you determine which option might be the better fit for your financial needs.
What are Home Equity Loans and HELOCs?
Both home equity loans and HELOCs allow homeowners to borrow against the equity they've accumulated in their homes. Equity is the difference between the current market value of your home and the outstanding balance on your mortgage*.
- A home equity loan is a lump-sum loan that is secured by your home's equity. You receive a fixed amount of money upfront, typically at a fixed interest rate, and repay the loan over a set term that usually ranges from five to 30 years. Monthly payments are predictable and include both principal and interest.
- A HELOC is a revolving line of credit that allows homeowners to borrow funds as needed, up to a predetermined credit limit, over a specified draw period that usually ranges from five to 10 years. During the draw period, you can access funds using checks or online transfers. You only pay interest on the amount you borrow, and payments fluctuate based on your outstanding balance and the current interest rate.
Differences Between Home Equity Loans and HELOCs
- Home equity loans provide a lump-sum disbursement, while HELOCs offer a revolving line of credit.
- Home equity loans typically have fixed interest rates, while HELOCs often have variable interest rates.
- Home equity loans have fixed monthly payments, while HELOC payments can vary based on your outstanding balance and the current interest rate.
Benefits of Home Equity Loans
- Predictable Payments. Home equity loans offer fixed interest rates and fixed monthly payments, making it easy to budget and plan for your expenses.
- Lump Sum Disbursement. You receive the entire loan amount upfront, which can be beneficial for large expenses or one-time purchases.
- Lower Interest Rates. Home equity loans typically have lower interest rates than other types of loans, such as personal loans or credit cards, because they're secured by your home.
Potential Drawbacks of Home Equity Loans
- Closing Costs. Like any mortgage or loan, home equity loans come with closing costs, including appraisal fees, origination fees and title insurance.
- Risk of Foreclosure. Failing to repay the loan could result in foreclosure, as home equity loans are secured by your home.
- Potential for Negative Equity. Taking out too much equity could result in negative equity, where you owe more on your home than it's worth.
Benefits of HELOCs
- Borrowing flexibility. HELOCs offer flexibility in borrowing, allowing you to access funds as needed during the draw period and repay them at your own pace.
- Interest-Only Payments. During the draw period, you have the option to make interest-only payments, reducing your monthly expenses.
- Reusable Credit Line. As you repay the principal balance, the available credit becomes available for future borrowing, making HELOCs a reusable source of funding.
Potential Drawbacks of HELOCs
- Variable Interest Rates. HELOCs typically have variable interest rates, which means your payments can fluctuate based on market conditions.
- Potential for Overspending. The flexibility of HELOCs can tempt homeowners to overspend and accumulate more debt than they can afford to repay.
- Risk of Foreclosure. Similar to home equity loans, failing to repay a HELOC could result in foreclosure, as they're secured by your home.
Which Option is Right for You?
Home equity loans and HELOCs are powerful financial tools that allow homeowners to tap into the equity they've built in their homes to achieve their financial goals. By understanding how each option works, weighing the benefits and drawbacks and considering your individual needs, you can make a smart decision that's right for you.
Choosing between a home equity loan and a HELOC depends on your individual financial situation, goals and preferences. Consider factors such as your borrowing needs, desired repayment structure, risk tolerance and ability to manage fluctuating payments. Consult with a financial advisor or mortgage professional to explore your options and make an informed decision that aligns with your long-term financial goals.
At Busey, we're here to help you explore your options and find the best solution to unlock the full potential of your home equity. To learn more about how we can help you take the next step toward achieving your financial dreams, visit busey.com/mortgage.
*Subject to credit and property approval. Because a Home Equity Loan and HELOC may have a longer term than some of the debt you may be consolidating, you may not realize a savings over the entire term of your new loan. Consolidating federal loans may eliminate important protections and benefits. Restrictions and limitations apply.