If you own a home, you might be able to tap into that equity to get cash for another purpose.
A home equity loan is a way to do just that. It’s essentially a second mortgage on your house with special privileges and benefits.
Home equity loans are simpler and cheaper than second mortgages, which are riskier but offer higher potential returns.
Home equity loans have lower monthly payments and no prepayment penalties.
You can borrow up to 80% of the value of your home, but that’s a high number as well.
Related Article: Home Equity Loan: 5 Great Reasons To Get A Home Equity Loan
There are several different types of home equity loans available– fixed rate, variable rate, balloon payment, and so on – depending on your needs and preference.
Here we’ll take you step by step through the process of finding and applying for one so you can get the money you need fast!
Image Source: FreeImages
Home equity loans and home equity lines of credit (HELOC) are financing options that allow you to borrow money against the value of your home.
They’re a type of second mortgage, which means they usually have a smaller loan amount and shorter loan term than your primary mortgage.
Home equity loans and HELOCs are different in many ways, but they both serve the same general purpose – giving you access to money that you’ve already essentially “stored” in your home.
There are some key differences between these two financing options, though. Understanding their pros and cons can help you decide which loan is best for your personal financial situation.
What is a Home Equity Loan?
A home equity loan (HEL) is a type of second mortgage that allows you to borrow against the value of your home, using the proceeds from the loan to pay for some other purpose. When you take out a home equity loan, you’re essentially borrowing against the equity in your home.
The equity in your home is the difference between its market value and the amount you still owe on your primary mortgage.
Home equity loans are usually smaller than the amount you owe on your primary mortgage, with a shorter term. The amount you can borrow and terms of the loan will vary by lender, but they’re generally smaller than the amount you could borrow through a home equity line of credit (HELOC).
You can use a home equity loan to finance home improvements, repairs, education or any other purpose that adds value to your home.
How to Get a Home Equity Loan?
The process for getting a home equity loan will vary depending on the lender you select.
You’ll likely need to provide standard documentation, like recent pay stubs, W-2s, bank statements and a copy of your two most recent years’ tax returns to prove your income, assets and creditworthiness.
Home equity loans are often larger than HELOCs — meaning you can borrow more money.
Lenders may require a higher credit score for a home equity loan, too. Remember, though, that taking out a larger loan now can limit your future borrowing power in case you ever need to take out a new mortgage. It’s wise to keep that in mind as you consider which loan might be right for you.
What is a Home Equity Line of Credit?
A home equity line of credit (HELOC) is a revolving line of credit that you can use again and again over the life of the loan.
The interest rate on a HELOC is generally lower than a home equity loan, but it’s fixed and won’t change for the life of the loan.
What’s more, the interest payments are applied to the principal balance of the loan, so they won’t decrease your loan amount.
A HELOC also allows you to borrow more money than a home equity loan, making it a better option if you have a larger project or expense in mind. When you take out a HELOC, you get a credit limit that you can draw upon whenever you need to.
You can access the money in a few different ways, including a line of credit, an equity line or a home equity loan.
When you take out a HELOC, you generally have to repay the full amount you’ve borrowed within a certain time period — usually 10 or 15 years.
Pros and Cons of a Home Equity Loan
A home equity loan has some advantages and disadvantages. The biggest advantage of a home equity loan is that it’s likely to be cheaper than a HELOC, since it has a lower interest rate and fixed payments.
That said, a home equity loan has a shorter repayment period that a HELOC, so it may not be a good option if you think you’ll need to borrow more money in the future.
If you think you might want to refinance your home at some point in the future and you’ve taken out a home equity loan, you may have difficulty getting a new loan, since lenders will see that you’ve already borrowed against your home’s value.
Pros and Cons of a HELOC
A home equity line of credit has some advantages and disadvantages.
Since it’s a revolving line of credit, you can borrow and repay as much or as little as you need.
That said, a HELOC has a higher interest rate than a home equity loan, and it’s less predictable, since the interest rate fluctuates.
What’s more, the interest rate on a HELOC is fixed — and it’s applied to the total amount you’ve borrowed, not just the principal.
If you’ve borrowed $100,000 and the interest rate is 5%, you’ll pay $5,000 in interest every year — and that amount will never go down, even as you repay your loan.
How to Choose the Right Loan?
A home equity loan and a HELOC are both excellent ways to access the equity in your home and use it for the benefit of your family and finances.
Both loans have a fixed interest rate and a fixed payment amount, so you won’t have to worry about rising interest rates, even as the Federal Reserve raises interest rates.
The biggest difference between these two options is the amount you can borrow. A home equity loan is smaller than a HELOC, so you’ll have to choose which loan is right for your financial situation.
If you have a large project in mind that costs more than a home equity loan can cover, a HELOC is a good option.
If you have a smaller project or expense in mind that’s less than the home equity loan amount, a home equity loan is a better option.
Final Words
A home equity loan and a home equity line of credit are both excellent ways to access the equity in your home and use it for the benefit of your family and finances.
But there are some key differences between these two financing options, including the amount you can borrow and the interest rate you’ll pay. And while both are excellent ways to access the equity you’ve accumulated in your home, a home equity loan is likely to be cheaper than a HELOC.
Now that you understand the differences between these two loans, you’re better equipped to choose which one is right for your situation.