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How does timing affect home equity vs. HELOC loans?

Q: We are planning a series of home improvement projects, and I've been getting mortgage quotes on both lump-sum home equity loans and a home equity line of credit. The lump-sum rates seem a little better, but since I'm not sure how long these projects are going to take, would I be better off with the HELOC so I don't pay interest until I need the money?

A: You might be wise to set up a spreadsheet to do some cash-flow planning based on the planned timing of your projects. This will help you tell whether the mortgage rate differential of the two loans is offset by the timing advantage of not having to pay interest on the HELOC until you actually need the money.

If some of these projects are still a year or two in the future, it might seem to give a clear advantage to the HELOC, since that would be a year or two of interest you could save on the cost of those projects, as opposed to borrowing all the money up front. However, another crucial factor is the future of mortgage rates. Today's mortgage rates are exceptionally low, but since HELOCs typically have variable rates, the longer these projects might stretch out, the more risk you would have of seeing rates rise. Naturally, anything you can do to compress the timing of your projects would help reduce this risk.

Finally, a wild card to look at in this decision is the timing of your repayments. A HELOC may give you more flexibility to pay down balances quickly, meaning that you can reduce interest expense on the back end of the loan (by repaying more quickly) as well as on the front end (by not paying interest until you access the money). However, you should check the prepayment penalties for both types of loans, and consider the possibility of whether or not you will be able to pay down balances ahead of schedule.

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