Money Smarts Blog

A few years ago my daughter was headed off to college and my bathroom was in desperate need of a makeover. I didn’t want Kaliah to be burdened with student loans after graduation and I also didn’t want to stare at the pink-tiled bathroom and leaky sink for one more minute. After a bit of research, I was terrified of the high interest rates that came along with a credit card. I decided using the equity in my home to pay for these things was my best move. I went the line of credit route since I wasn’t sure exactly how much money I’d need. This gave me the flexibility to take out as much or as little cash as I needed with a rate way lower than my credit card. Goodbye carpeted bathroom, hello heated tiles. Oh yeah, and Kailah is gearing up for graduation this May, student loan free!

Sounds great, right? Read on to find out if using the equity in your home to pay for life’s adventures is right for you.

What exactly is a home equity loan anyway?

A home equity loan, often referred to as a second mortgage, allows you to borrow money for large expenses or to consolidate debt by leveraging the available equity in your home. Your home equity is based on the difference between the appraised value of your home and your current balance on your mortgage. For example, if your home is valued at $350,000 and you owe $200,000 on it, your equity is $150,000.  

When it comes to home equity loans you have two options: a fixed-rate home equity loan or a home equity line of credit (HELOC). With a home equity loan, you receive the money you are borrowing in a lump sum payment at a fixed interest rate that will be paid off in a specific term. With a line of credit, you can borrow or draw money as needed from an available maximum amount. A HELOC is like a credit card. Rather than a loan in a lump sum, you have access to a set line of credit that you can borrow against repeatedly during the loan’s borrowing period (or term). 

Home Equity Loan

Pros

• Interest rates are usually fixed. If interest rates rise, your payments are not affected.
• Lower cost of borrowing. Interest rates on home equity loans are typically lower than the rates for personal loans or credit cards because your home is used as collateral.
• You’ll receive cash from the loan in a lump sum. 
• Use for whatever you need. You can use a home equity loan to start a business, pay for a vacation, purchase an investment or for any other purpose. Some reasons for using a home equity loan may be better than others, but once you’re approved, you can use the funds sum for whatever you want.

Cons:

• Higher interest rates. Interest rates are usually higher for home equity loans than they are for HELOCs because you’re trading a lower variable interest rate in exchange for stability in the fixed rate you’ll pay over time.
• Your home could be at risk. Using your home as collateral usually means paying a lower interest rate for a home equity loan than you would for an unsecured loan. But if you default on your loan, the bank may foreclose on you and take your house.
• Costs and fees. Home equity loans typically come with closing costs and fees. You may be able to roll these into the loan amount, but these costs should be considered when you’re comparing your options.

Home Equity line of Credit (HELOC)

Pros

• Flexibility in the amount you borrow and when. Like a credit card, you only use what you need when you need it.
• Payments don’t start until you access your funds. You do not have to pay interest on the line of credit until you withdraw the money.
• Lower interest rates. Initially, rates on HELOCs are typically lower than those of fixed rate home equity loans.

Cons

• Unpredictable payments. HELOCs are typically adjustable-rate loans. If interest rates go up, so will your monthly payments.
• Your home could be at risk. Just like a home equity loan, a HELOC uses your home as collateral. If you default on your HELOC, the bank may foreclose on the property.
• Fees and penalties. HELOCs can come with many fees and penalties such as an annual fee. Before you take out a HELOC, make sure you know whether the lender will charge an annual fee. Some lenders will waive the annual fee for the first year or beyond. Talk to your lender and read the fine print.

The biggest takeaway is that no matter which route you go, your home could be at risk. Taking a loan out against the equity in your home is a big decision so make sure you have a plan and budget in place to pay it back.

Overwhelmed? We get it and that’s why we’re here to help. Give us a call or stop by and we’ll discuss your questions and concerns. Our experts can guide you in finding the best fit for you.