Choosing a Home Equity Loan or Line

 

 

Do you need a way to pay for large expenses, such as sending your child to college or renovating your kitchen? Or do you want to eliminate those outstanding credit card balances once and for all? The answer can literally be in your own backyard. If you have sufficient equity, you can borrow at a low interest rate; as a bonus, interest payments are generally tax deductible.

There are two basic methods for using your home as collateral: a loan with equity and a credit line for home equity (HELOC). Here are the points that you should consider when choosing between them. (For a quick iBig Daddy division, see Home-Equity Loan vs. HELOC: The Difference ).

What is the money for?

What is the money for?

First question: what is the purpose of the loan? A loan based on equity, also called an installment loan at home, is a good choice if you know exactly how much you need to borrow and for what you will use the money. You are assured of a certain amount that you will receive in full when you close it. “Home equity loans are generally preferred for larger, more expensive goals such as remodeling, paying for higher education or even debt consolidation, since the funds are received in one go,” says Richard Airey, a loan officer at Finance of America Mortgage in Portland, Maine. Of course, when you apply, there may be some temptation to borrow more than you need right away, because you only get the payment once and you don’t know if you’ll be eligible for a new loan in the future.

Conversely, a HELOC is a good choice if you are unsure how much to borrow or when. Generally it gives you continuous access to money for a certain period (sometimes up to 10 years). You can borrow against your own line, repay all or part of it and later borrow that money again, as long as you are still in the iBig Dadididifying period of HELOC. However, a credit line can be withdrawn. If your financial situation deteriorates or the market value of your home falls, your lender may decide to lower or close your credit limit altogether. So while the idea behind a HELOC is that you can draw on the funds when you need them, your ability to access that money is not a certainty. “HELOCs are best used for short-term goals, say 12 to 20 months, because the interest rate can fluctuate and is generally tied to the highest rate,” says Airey.

Factor of Interest

Factor of Interest

An important consideration in obtaining a home equity loan or a HELOC was jareBig Daddyang’s interest rate. The rates on HELOCs were usually at least a full percentage point lower than the rate on equity loans, so it was tempting to choose HELOC, although the rate is variable, while the percentage of a home mortgage loan is set (more below) ).

Today, however, HELOCs have a negligible advantage over equity loans. According to Bankrate’s weekly survey of major lenders on September 9, 2015, a loan with a USD 30,000 loan had an average interest rate of 5.22% and HELOC had the same average interest rate of 4.75%, a difference of less than half a half per cent. (Learn more about an important factor affecting interest rates in How the Federal Open Market Committee Generates Meetings and Stocks .)

However, you must not only take into account the current difference in interest rates, but also be guided with interest rates. If you think that they will remain the same or decrease, you can opt for the lower rate from the HELOC. If you think interest rates are going up, a loan with equity may be the best choice. Analysts even expect interest rates to rise in the near future, making closing the low mortgage interest rates of today very useful. (See Home Equity loan rates for more information.)

Payback time

Payback time

It is also important to consider how each loan is structured. A loan with equity works like a conventional fixed-rate mortgage. You borrow a fixed amount at a fixed interest rate and you make equal payments for the entire loan period, which can last between five and 30 years. Whatever the period, you have stable, predictable monthly payments during the term of the loan.

In contrast, the duration of a HELOC consists of two parts: a draw period and a repayment period. The draw period, during which you can withdraw money, can last 10 years and the repayment period can last 20 years, so that the HELOC receives a 30-year loan. Once the draw period has ended, you cannot borrow more money.

During the draw period of the HELOC you have to pay, but these are usually small, which often comes down to paying back only the interest. During the repayment period, payments will be considerably higher, because you now repay the principal sum. US Bank, for example, lets its HELOC borrowers choose to either pay interest only or 1% or 2% of the outstanding balance during the draw period. During the 20-year repayment period you must repay all the money that you have borrowed, plus interest at a variable interest rate.

That leap in payments at the start of the new period has led to a payment shock for many from an unprepared HELOC borrower. If the amounts are large enough, it can even put those who are in financial difficulty in default. And if they don’t make the payments, they can lose their house – the collateral for the loan, remember.

The long view

The long view

If you are the type of person who gets a good idea of ​​your financial decisions, a loan with equity can make more sense. Because you borrow a fixed amount at a fixed interest rate, taking out a loan with equity means that you know how much you pay for the loan in the long term when you pay it out (although you can reduce that amount) if you repay the loan early or refinance at a lower rate). Borrow $ 30,000 on 5.5% for 20 years and you can easily calculate that the total financing costs, including interest, are $ 49,528.

With a HELOC you know that the maximum that you may borrow is the amount of your credit limit, but you do not know how much you will actually borrow. You also do not know what interest you pay. This means that it is difficult to calculate the costs of a HELOC in the long term.

Of course it can also be easy to fit a HELOC into your large photo if you just want to have a credit limit at hand, and you do not intend to use it much. But if you intend to draw intensively at the HELOC and want to know what your assets can look like in 20 years, it is much harder to anticipate.

The best of both worlds

 

Can’t choose between the two vehicles? Don’t worry: there are ways to get some of the stability of a mortgage loan with a certain flexibility from HELOC. Some lenders give borrowers the option of converting a HELOC balance into a fixed-interest loan. For example, US Bank lets you set a fixed interest rate for terms such as 15 or 20 years on all or part of your variable interest company. You can have a maximum of three fixed-interest balances simultaneously. Bank of America and Wells Fargo also offer fixed-rate options on their HELOCs (which they actually use to replace home capital loans that they no longer offer).

Pentagon Federal Credit Union, one of the largest credit unions in the country (where anyone can join for a small fee) offers another interesting option: a 5/5 HELOC, where interest rates change only once every five years.

The bottom line

 

Keep in mind that just because you can borrow against your equity does not mean that you should. But if you have a need, there are many factors to consider when determining the best way to borrow: how you will use the money, what the interest rates may be, your long-term financial plans and your tolerance for risk and fluctuating rates.

Some people do not feel comfortable with the variable interest rate of the HELOC and prefer the loan with equity for the stability and predictability of knowing exactly how much their payments will be and how much they owe in total. Home equity loans are much easier to work in a budget, as Airey indicates. Moreover, ‘fixed loans for residential capital result in less frivolous spending’. With a HELOC, ‘low interest payments and easy access can be tempting for those who are not financially disciplined. items, just like a credit card, “says Airey (see How HELOCs can hurt you ). However, if you have that discipline, and like the idea of ​​a more open source of funds, the rule of credit may be the option for you .