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Home Equity Loan or Line of Credit: Which Works for You?

Posted by  on Jul 27, 2011
 

Mortgage lenders offer home equity loans, which are structured loans for a specified amount with scheduled payments and repayment term. Home equity lines of credit, popularly called HELOCs are lines of credit secured by homes. HELOCs work in a manner similar to credit cards; you use your HELOC and pay interest only on the amounts borrowed. Home equity loans and HELOCs share certain features, but also differ:

Home equity loan and HELOC similarities

  • Home equity loans and HELOCs are secured by your home.
  • Home equity financing diminishes home equity. This can be risky in unstable or declining real estate markets.
  • Home equity loans and lines of credit cost less than refinancing your mortgage, and are generally less expensive than using unsecured consumer credit (credit cards, personal loans, vehicle loans).

Deciding whether a home equity loan or HELOC matches your needs

Home equity loan fees are generally lower than those of HELOCs, but both are much less expensive than refinancing a mortgage. Home equity loans come with fixed or variable rates, while HELOC rates are variable (once you stop drawing on the credit line, you may be offered the opportunity to fix your rate). Home equity loans are useful when you have a one-time expense--consolidating credit card debt, for example. HELOCs are great when you need flexibility--for instance, to pay college tuition each semester.

HELOC to the rescue: Emergencies and home remodeling

HELOCs provide convenient cash when emergencies occur. Planning to remodel your home? Construction cost over-runs can occur, and your HELOC is useful for paying contractors as your project progresses. HELOCs provide a financially friendly alternative to high APR credit cards, but they can also sabotage your budget if used indiscriminately.

Home equity and home value: A close association

When home values decline, homeowners may discover that they owe more in mortgage loans than their homes are worth. Here are tips for keeping your home safe from being "under water" or in foreclosure:

  • Plan for your financial needs before borrowing against home equity. Opening a HELOC you don't need can lead to non-essential spending.
  • Save for emergencies: A HELOC can bail you out of emergency expenses, but saving for emergencies helps prevent unplanned use of your HELOC.
  • Keep tabs on home value trends in your neighborhood. This is helpful for monitoring your home equity and can help with planning when or if to use home equity financing.
  • Avoid "over-improving" your home: Before borrowing for major home improvement projects, make sure that your planned improvements are in line with current real estate market trends and comparable to improvements typical in your area.
  • Don't use home equity financing or a cash-out refinance mortgage for non-essential expenses.

Discussing your financial plans and goals with a professional advisor is helpful for determining your right home equity financing option. Request home equity quotes from mortgage brokers and lenders and fund your best rates and terms.

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