There are many confusing terms that are thrown around in the
mortgage
world. Two such terms that you may have heard before are home equity loan
and home equity line of credit. These two forms of cash advances allow you to
access the equity you have in your home in the form of usable money. This allows
you to fund things that you may not have had enough money for, like education,
medical bills, or home repairs and remodels. However, both of these are
different and have their own uses and benefits.
Home Equity Loan
A home equity loan is a loan
that you take out on top of your mortgage, using the equity you have in your
home as collateral. Equity is the difference between the market value of your
home and the current balance of your home loan. So, if your home is worth
$500,000 and the remaining balance of the home loan is $200,000, that means you
have $300,000 of equity in your home. In other words, equity is the percentage
of your home that you own, versus the percentage your lender
owns.
How much money can you get? When taking out a home equity
loan, you have access to an amount equal to your total equity in the house. In
the example above, you have $300,000 of equity, so you could take out a home
equity loan of up to $300,000.
Since you get the entire amount of the
loan up front, a home equity loan is perfect for significant one-time expenses
such as:
- A down payment on a house or other property
- A new car
- A consolidation of debt
Interest for a home equity loan is at a
fixed rate. This gives you consistent monthly payments, making budgeting and
planning simple.
Home Equity Line of Credit (HELOC)
A home equity line of credit
is a lot like a credit card. When you apply for one, your lender approves you
for a specific amount of credit that you then get access to. Instead of getting
a large lump sum, you can make withdrawals from your line of credit. So, if you
have a $1,000 line of credit and you withdraw $200, you’ll have a remaining
balance of $800 from whcih to make withdrawals. If you then repay some, say
$100, your available credit will go up to $900.
Just as with a home
equity loan, a home equity line of credit uses your home as collateral.
Additionally, the lender uses the value of your home to figure out what your
line of credit will be. To determine your line of credit, a lender usually takes
a percentage (say 75%) of your home’s appraised value and then subtracts the
amount owed on the mortgage. For example:
| Appraised value of home |
$200,000 |
| Percentage |
x 75% |
| Percentage of appraised value |
=$150,000 |
| Balance owed on mortgage |
- $100,000 |
| |
|
| Potential line of credit |
$50,000 |
Many lenders put a time limit
on using your line of credit, such as ten years. This period is called the draw
period. Once the draw period ends, you enter the repayment period. Once in the
repayment period, you can no longer make withdrawals from the line of credit and
will have to start paying off the balance. Some lenders require you to pay the
full amount as soon as the draw period ends; others may give you more time
(e.g., 5 years, 10 years, etc.). Another option you might have is to apply for a
renewal of the line of credit. If approved, a new credit line would be
determined and the remaining balance of the old one would be rolled into the new
one.
While a home equity loan is good for major one-time expenses, a line
of credit is good for ongoing expenses like:
- Home improvements
- Educational or medical expenses
- Major life events like a wedding or new baby
The interest rate for
a home equity line of credit is usually variable, meaning it fluctuates with
changes in the housing market. Sometimes, though, lenders offer different
options like variable rates with fixed-rate options or fixed rates once you
enter the repayment period.
Just like with a mortgage, you should look at
several lenders when you want to get a home equity loan or line of credit.
Consider all of the options they offer, and then select the lender that is the
best fit for your situation.