Home Equity Loans and Lines of Credit Differences
Your home equity is the percentage of your home that you own – the home’s value minus the amount you owe on your mortgage. You can use this equity to your advantage if you’re in need of cash by taking out a home equity loan or a home equity line of credit (HELOC). Before you tap into your equity, learn the differences between your two options.
Home Equity Loans
When you take out a home equity loan, you are essentially getting a second mortgage. You’ll borrow money from a lender using your home as collateral, just as you did for your first mortgage. Most lenders will not allow you to borrow more than 80 or 90 percent of a home’s total value, and they include your first mortgage in that calculation.
Because a home equity loan is similar to a mortgage, you will get a lump sum from your lender and pay it back in equal monthly installments on an amortization schedule with a fixed interest rate.
Home Equity Line of Credit
A home equity line of credit shares many features in common with a home equity loan, such as the borrowing limits and tax advantages. The main difference is that a HELOC is a form of revolving credit, like a credit card. A HELOC normally has a draw period; typically that draw period lasts about five to ten years. If you reach your limit, you’ll have to pay some of it back before you can use it again (Just as you would with a credit card).
How to Choose
As a rule of thumb, you’d usually take out a home equity loan if you needed all of the money at once, such as for a home improvement project for which you’ve already received estimated costs from a contractor. If you’ll need money in installments, as you would if you were using it to finance an education, a HELOC is the way to go. You should also consider current interest rates and how you think they’ll be over the course of your loan, because you could be choosing between a fixed rate and a variable rate. Also, make sure to calculate how much you can afford to pay back in monthly installments and at the end of the loan’s term. Whichever option you decide on, it’s important to do your homework, research your choices and shop around for lenders as you did when you took out your mortgage. Click here to learn more about the Home Equity Services provided by First National Bank.
Article written by Jacki Foley, Vice President at First National Bank.