All About Home Equity Loans and Lines of Credit
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Here’s the thing: At some point, you’re going to need a big chunk of change. And you’re going to need it kinda…now.
Maybe it’s for something you’ve expected (such as a long-planned-for home renovation), or maybe it’s for something that snuck up on you (braces for little Katie). The result is the same though: You need some money, and it’s more than you are holding in your checking account.
There are a number of different ways to raise the cash, of course. Here are some:
a) Start maxing out your credit card. When it’s full, get another one. Rinse and repeat.
b) Consider a rewarding (and profitable!) career as a drug mule
c) If you own your home, use its value to get a home-equity loan or a home-equity line of credit (HELOC)
Answer “a” is a pretty lousy option that’s likely to put you deeper in a hole than whatever you need the money for, while answer “b” may actually result in you being placed in a hole. In the ground. With dirt on top. So let’s talk a little about answer “c.”
A home-equity loan or a home-equity line of credit (HELOC) is a second loan (after your mortgage) you take out on your house (You ever hear people talk about a “second mortgage?” That’s what this is.) But where the first loan went towards the purchase of your home, the second loan is cash given directly to you, to do with as you please. You can use it for a much-needed home renovation, or to cover living expenses if you lose your job or to help pay for medical bills.
Notice the examples above. They’re all pretty serious, right? You don’t see “Weekend in Cabo” up there, do you? That’s because, as is the case with all borrowing, you shouldn’t use this kind of loan for anything frivolous. Home-equity loans of all stripes cost money since you have to pay interest when repaying them. Sometimes those costs are necessary (to increase the resale price of your home, or in an emergency), but paying interest on money so you can go buck wild at the Bellagio is likely to bite you in the ass down the line.
What’s the difference between a home-equity loan and a HELOC? Here’s how it breaks down:
A home-equity loan is like your mortgage (that is, a loan where your house is the collateral), only smaller. Once you’ve been approved, you get a check for the total loan amount. Home-equity loans have a fixed interest rate and a fixed term (amount of time you have to pay back the loan), usually around 10 to 15 years. You make monthly repayments on the loan until you’re paid up.
With a HELOC, you’re approved for a total loan amount, but it’s not given to you in one lump sum. You get a credit/debit card, or a checkbook (or both) and you withdraw money when needed. You only pay interest on the amount you have out, and you’re only limited by the total amount of the loan.
HELOCs, for their added convenience, are trickier. For starters, the interest rate fluctuates, so your payments can increase (sometimes drastically: some lenders offer a ridiculously low “introductory rate,” only to jack it to the high heavens after a month or two). HELOCs also have more complicated terms. Some will only let you access the money for, say, five years (known as the “advance period”). After then, you can’t withdraw money anymore and you have to repay whatever you borrowed over the next ten years (known as the “repayment period”). Some only charge you interest for ten years, but then want the whole loan paid off at once (known as a “balloon payment”).
So which one is best for you? Well, if you have a single, discrete expense (like a kitchen remodel), a regular home-equity loan is the right move. You gets your money, you pays for your project and you start repaying the loan right away—in monthly payments that never change over the life of the loan.
But if you’re looking at a series of payments over a period of time, or want a safety net that you can bail you out at a moment’s notice, a HELOC is the better choice—you’ll only pay for the money you need.
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