“Home rich, money poor” is more than just a catchy saying – it applies to thousands of homeowners. With trillions of dollars tied to the value of their homes, Americans may want to tap into that money for a variety of reasons. A home equity loan and a home equity line of credit (HELOC) are two popular ways to borrow money against the value of your home, and thanks to very low rates right now – see the lowest fares you can claim here — many owners are considering buying one. But are they right for you?
Deciding which option is best for you goes beyond comparing interest rates and requires you to think about what you need the money for and how you plan to pay it back. Sometimes the basic questions are very revealing. That’s why you should consider your overall financial situation and why you’re considering a HELOC or home equity loan in the first place, advises Amy Richardson, Certified Financial Planner at Charles Schwab. It begins by asking clients the following question: “How will the funds be used?” »
When thinking about how you will use the money, consider whether you need a lump sum loan to pay for something specific (you might want to opt for a home equity loan in this case) or whether you want tap into the equity in your home, like a credit card, in which case you may want a HELOC.
Additionally, it’s also important to think about how you feel about debt, how long you plan to stay in the house, and the prospect of rising interest rates, advises Richardson. “It’s partly an internal philosophical piece,” she notes, adding that your choice of a HELOC versus a home equity loan might come down to personal preference.
Home equity loans: best if you know how much money you need
Home equity loans allow homeowners to borrow a predetermined amount of money at a fixed interest rate. Loan terms vary from bank to bank, but homeowners can generally borrow up to 85% of their home’s equity, depending on the FTC.
A home equity loan is the best choice for homeowners doing major renovations, such as adding an office or adding new space to the home, says Audrey Blanke, Certified Financial Planner at Baird. “The great thing is that you have a fixed payment, you can pay off the loan sooner if you want and another advantage is that you can always choose to refinance it in the future.”
With a home equity loan, you’ll lock in an interest rate for a set period of time and then pay the same amount each month, similar to a home loan, notes Richardson. “If you know how much money you need to borrow, a home equity loan can be a great place to start.”
HELOCS: Ideal if you don’t know how much money you need
Sometimes you’re not sure how much money you need – and HELOCs offer more flexibility in such situations. These lines of credit allow you to tap into the equity in your home, using as much (or as little) as you need when you need it. The catch is that most HELOCs have variable interest rates, so once you start paying off the line of credit you used, you might be in for a shock if rates have gone up, warns- she.
This is why it is important to be aware of what you are using the money for in the first place. “A HELOC is good security when there’s a home project that has some uncertainty, and you don’t know exactly how much it will cost.”
In addition to the risk of rising rates, you need to be aware of your own relationship to debt, says Richardson. “Without discipline, you risk overspending or using that line of credit for other purposes, creating more debt for yourself, which really becomes a hindrance to your financial future once that line of credit is due.”
Do your homework before getting a HELOC or home equity loan
Home equity loans and HELOCs leverage the value of your home, so you may have more equity at your disposal since home prices have risen. The interest rates you will get for either of these options, however, will depend on your credit score. This is why it is important to do your research.
“Make a few calls, as terms may vary, and make sure you not only understand your loan repayment terms, but are comfortable with them,” says Richardson. Because of the variable rate structure with HELOCs, you can start out with a low rate that goes up, so it’s important to consider your overall financial situation and that you can afford to take on that debt, he adds. -she. “All of these factors are important, and you won’t get the full terms without speaking to a lender’s representative.”