The difference between the value of your property and your outstanding mortgage balance is referred to as your home’s equity. You would typically hope that over a period of time your mortgage will decrease, your property’s value will increase, thus meaning that the equity available to you will also increase.
Many people look to borrow from the equity in their homes, and this can generally be done via either a home equity loan or home equity line of credit. A home equity line of credit can best be described as a revolving line of credit, much like a credit card. In fact, there are further similarities to a credit card such as your lender will set a maximum limit when you take out a home equity line of credit (HELOC).
You can borrow from a HELOC by using lender provided checks, or a specific credit or debit card that is tied to your line of credit. As soon as you borrow money from a HELOC this amount will be deducted from your overall limit. As soon as you start repaying this money, the full amount will once again be available to you further down the line.
The main difference between a HELOC and a home equity loan is that a HELOC will usually have a variable interest rate, whereas a home equity loan will generally offer a fixed interest rate. Additionally, a HELOC only requires you to pay the interest portion of the amount you have borrowed. However, this will obviously mean that at the end of the HELOC term you will be required to pay the outstanding balance in full.
In order to avoid this many people choose to pay a small percentage of the outstanding balance on a monthly basis, thereby allowing them to repay the loan faster. As a home equity line of credit has a variable interest rate you should find that the interest rates offered will be lower than that of a home equity loan. In fact, the rate can often be significantly lower, such a percentage point or two below that of a home equity loan.
A home equity line of credit is best suited to a borrower who wishes to make a purchase, but needs to spread the cost over a period of time. A number of prime examples of this may include:
Home improvements – If a contractor is completing your home improvements in stages, they will generally require payment at specific intervals. If you have taken out a home equity loan you will be charged interest on the full amount from the day the money hits your checking account. However, with a home equity line of credit you are only charged interest on the amounts you withdraw from the day you withdraw the money.
Medical bills – If you or a relative is undergoing a course of treatment, payment will typically be required at various stages. This is where the benefits of a HELOC far outweigh any other type of loan.
College financing – College tuition bills are normally due every semester, so once again you can budget for this accordingly with a home equity line of credit.
The main advantage of a home equity line of credit, as you can plainly see, is that you only ever pay for the portion of the loan that you actually use, and not the full amount. This will, of course, result in substantial savings over a period of time. You should also be aware that there are no closing costs associated with HELOCs, and the fact that you can link the funds to your checking account makes them easily accessible.
There are also disadvantages to a HELOC and these include the amount of home equity you have used will not be available to you when you sell your home. The other main disadvantage is the fact that the interest rate offered is variable. Therefore if market rates rise so will the rate and payment of your home equity loan. In some cases you may even find that a HELOC has an annual fee.
Most home equity loans are generally offered for either 15 or 30 years, although they can also tie in with the remaining term of your mortgage. You will also find that the more you borrow with a HELOC the lower the interest rate charged will be. Home equity loans are usually only available at much higher interest rates than a standard mortgage, however, a HELOC will see interest rates more in line with that of a traditional first mortgage.