Home Equity Explained
Home equity loans essentially mean that you’re borrowing against the value of your home twice — the first time to actually pay for the house and the second for outside costs. It’s possible that you hear the terms home equity loan, home equity line of credit and second mortgage used to define the same thing. That’s because they essentially are the same thing, though there are differences.
Home Equity Loans
A home equity loan is also known as a second mortgage, which means that you receive the loan with a fixed interest rate over the course of the predetermined term of the loan repayment. A home equity line of credit, however, is not unlike a credit card in that the amount of money you borrow is determined by your credit history and how much money you make.
Funds for a home equity line of credit can be paid down and then used again — like a credit card — but a home equity loan is a single loan paid over a certain amount of time with a fixed interest rate. The reason that a home equity loan is known as a second mortgage is because the person borrowing almost always has a first mortgage.
There are certain situations in which you should consider a home equity loan versus a home equity line of credit. Home equity loans are good for things like weddings, where you’re looking to fund one major expense and pay it back on a schedule. Home equity loans are also good for debt consolidation and second home purchases. The main thing to keep in mind with home equity loans is that you’ll also incur closing costs, just as you would any mortgage. Although your credit score will decrease if you miss payments, your loan balance won’t affect it.
A home equity line of credit (HELOC) would be an option if you’re looking to have extra money at your disposal at certain times — not unlike a credit card. There are monthly minimum payments associated with acquiring a HELOC, and they vary based on the line of credit you receive. Home equity lines of credit are often attractive because you have ongoing funds available, but there are several cons to going this route.
The biggest risk to getting a home equity line of credit is that you have to sign over your house as collateral, and if you miss payments you risk foreclosure. Your credit score can also be severely affected if you don’t make payments on time.
Be Aware Of The Interest
Interest rates are incredibly important to consider in both home equity loans and lines of credit. Home equity loans have fixed interest rates, but interest rates on home equity lines of credit fluctuate depending on the market, so you might end up paying higher at different times. HELOC’s, however, will only require you to pay interest on the money you’ve withdrawn.
If you need extra money for expenses or a major project or investment, home equity loans or lines of credit can be good options. Always make sure to do your research to figure out which works best for you, and weigh the pros and cons before committing to either one.