“Rich in houses, poor in cash” is more than just a catchy saying – it applies to thousands of homeowners. With trillions of dollars tied up in the value of their homes, Americans may want to use that money for a variety of reasons. A home equity loan (HELOC) are two popular ways to borrow money from the value of your home thanks to very low interest rates right now – see the lowest prices for which you can qualify here Many homeowners are thinking of one. But are they right for you?
Deciding which option is best for you involves more than comparing interest rates and requires you to think about why you need the money and how you plan to repay it. Sometimes the basic questions are very indicative. This is why you should consider your overall financial picture and why you are considering a HELOC or equity loan in the first place, advises Amy Richardson, a certified financial advisor at Charles Schwab. It starts by asking customers the following question: “How will the funds be used?”
When thinking about how to use the money, think about whether you need a one-time loan to pay for something specific (you may then want to choose a home equity loan) or want to use your own funds, such as a credit card, so you can to want a HELOC.
In addition, it’s important to think about how you feel about borrowing, how long you plan to stay home, and how you feel about the prospect of raising interest rates, Richardson advises. “Some of them are an internal, philosophical piece,” he notes, adding that your choice for a HELOC loan over a home loan could depend on personal preference.
Housing equity loans: The best if you know how much money you need
Housing equity loans allow homeowners to borrow a fixed 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 equity, according to FTC.
A home equity loan is the best choice for homeowners who are making big improvements to their home, such as adding an office or adding new space to their home, says Audrey Blanke, a certified financial consultant with Baird. “The great thing is that you have a fixed payment, you can repay the loan earlier if you want it and another benefit is that you could always choose to refinance it in the future.”
With a home equity loan, you can lock in an interest rate for a fixed period of time and then pay the same amount each month – similar to a home equity loan, Richardson notes. “If you know how much money you need to borrow, a home equity loan can be a great place to start.”
HELOCS: Better if you do not know how much money you need
Sometimes you do not know exactly how much money you need – and HELOCs offer more flexibility in such situations. These credit lines allow you to raise equity in your home, using as much (or as little) as you need when you need it. The problem is that most HELOCs have variable interest rates, so once you start repaying your credit line, you may be shocked if interest rates rise, he warns.
That’s why it’s important to pay attention to what you use the money for first. “A HELOC is a good failure when there is a household project that has some uncertainty and you do not know exactly how much it will cost.”
In addition to the risk of interest rate hikes, you need to be aware of your own debt relationship, says Richardson. “Without discipline, you may run the risk of overspending or using this credit line for other purposes, thus creating more debt for yourself, which will really be an obstacle to your financial future once this credit line is completed.”
Do your homework before taking out a HELOC loan or home equity loan
Both mortgages and HELOCs affect the value of your home, so you may have more equity at your disposal as house prices go up. However, the interest rates you will receive for any choice will depend on your credit score. That’s why it’s important to do your research.
“Make a few calls because the terms may be different and make sure you not only understand your loan repayment terms but also that you feel comfortable with them,” says Richardson. Due to the variable interest rate structure with HELOCs, you could start with a low interest rate that goes up, so it is important to take into account your entire financial situation and be able to take on this debt, he adds. “All of these factors matter and you are not going to receive the full terms without talking to a representative to a lender.”