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HELOC Vs. Home Equity Loan: Which Is Best For You? Thumbnail

HELOC Vs. Home Equity Loan: Which Is Best For You?

Are you a homeowner needing extra cash for a home renovation or another purpose? If so, how will you finance the project? Two common financing tools tap into home equity (the value of your home less total debt outstanding on your home): a Home Equity Line of Credit (HELOC) and a Home Equity Loan. Do you know the difference between the two? Most homeowners think they are the same thing – but this is not the case.

Home Equity Loan Vs. HELOC: What is the Difference?

With a Home Equity Loan, you receive an upfront lump sum that is repaid in fixed payments. A HELOC enables you to tap into equity as needed - up to a certain limit. Most home equity loans have fixed rates while a HELOC typically has a variable interest rate that changes over time depending on the interest rate environment.

· Home Equity Loan

A home equity loan is a second mortgage that enables using the equity in your home as “collateral” to borrow money. You use your home as security to protect the lender if you default on the loan. Your lender loans money as a lump sum at a fixed interest rate. You make your monthly payments (principal and interest) during a repayment period. You can generally borrow around 80% to 85% of the value of your home, minus what you owe on your primary mortgage.

· Home Equity Line Of Credit (HELOC) A HELOC is a different type of second mortgage allowing you to borrow money against the equity in your home as a line of credit. Equity in your home can pay for whatever you need, including home improvements, education, and credit card debt consolidation. A HELOC has two phases: the draw period and repayment period. The draw period is the time when your line of credit is open and available for you to use. During this period (10 or 15 years), the only payments required are interest payments on any funds borrowed. At the end of the draw period, the borrower must make repayments based on the principal and remaining interest. Most HELOCs have variable interest rates, which fluctuate based on the changes in the market.

How Are HELOCs and Home Equity Loans Similar?

· Both are secured loans. Secured loans are backed by collateral and can result in the loss of your home in the case of foreclosure. In contrast, unsecured loans, such as personal loans, do not require collateral but carry higher interest rates because the lender is taking on more risk.

· Both have closing costs. Closing costs are the fees and expenses paid to your lender when closing on a loan.

How Are HELOCs and Home Equity Loans Different?

These tools have two different types of interest structures: fixed rate and variable rate.

o A fixed interest rate doesn't change during repayment of the loan. A home equity loan almost always maintains the same interest rate. If the loan’s interest rate = 6%, the loan retains that same interest until the loan is paid off in full.

o A variable interest rate fluctuates based on an underlying benchmark index or interest rate. A HELOC usually has a variable interest rate, and as interest rates rise, the interest on your HELOC also goes up.

· There are two types of borrowing: installment credit and revolving credit.

o Installment debt is paid over time with regularly scheduled payments. A home equity loan and an auto loan are examples of installment loans.

o Revolving debt is open-ended. If the balance on revolving credit account is not paid in full every month, the unpaid portion carries over into the next month. Revolving debt includes credit cards, personal lines of credit and HELOCs.

What are the Advantages and Disadvantages of Each?

Home Equity Line of Credit (HELOC):

Advantages

· Don’t pay any $ unless you use the money

· Usually offer a lower initial rate, then change to a variable rate

· Are easier and less costly to obtain

Disadvantages

· Easy to spend more $ than originally planned

· Variable rates can make your debt grow more rapidly when rates rise

· Can lose your home if you do not repay

Home Equity Loan:

Advantages

· Fixed rate over life of loan

· Operate as an installment loan

· Lower closing costs that refinancing your mortgage

Disadvantages

· Repayment begins immediately

· Higher closing costs than a HELOC

· Can lose your home if you do not repay

Consider carefully which type of financing is right for you before applying for your financing needs.

If you are not currently working with FPS, we would be happy to talk with you. Questions? We are here to help.

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Best regards,

Janet Rhodes Friedman, CFP®, CDFA®, MBA

Janet@PlanWithFPS.com

617-630-4978

Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page

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