Spring is here, and it’s a natural time for homeowners to start thinking about doing some home improvements and updates. Either a home equity loan or a home equity line of credit (commonly referred to as a HELOC) could be a good way to finance these types of projects. But, what exactly is the difference between them?
Let’s start with what the two have in common.
Home equity lines of credit and home equity loans are often referred to as second mortgages, since they are secured by your property. They’re usually repaid over a shorter period of time than your original mortgage, although the repayment period can vary depending on the lender.
“Equity” is the difference between how much your home is worth and how much you owe on your mortgage. The amount of equity you have in your home helps to determine how much money you can borrow with a home equity loan or line or credit.
Figuring out your property’s equity is fairly straightforward. For example, if you purchase a home for $100,000 by borrowing $80,000 and making a down payment of $20,000, you’ll start off by having $20,000 worth of equity in your home.
Your equity will typically increase over time as you make monthly mortgage payments (reducing the amount you owe on your home), and if the value of your home rises. As an example, let’s say that after several years that $100,000 home you purchased is now worth $120,000, and the amount owed on your mortgage is now $70,000. Your home equity would now be $50,000.
With both home equity loans and home equity lines of credit it’s important to remember that your property is what serves as the guarantee that you’ll repay your debt. If you don’t make your monthly payments, the lender could foreclose on your home. Also, with either a home equity loan or line of credit, you’ll usually have to pay off the balance when you sell the house.
So, how do home equity loans and home equity lines of credit differ?
With a home equity loan the borrower receives a one-time lump amount that they must pay off over a specific time period. The loan has a fixed-interest rate and fixed monthly payments. A home equity line of credit, on the other hand, is more like a credit card because it has a revolving balance. With a home equity line of credit, you can borrow up to a certain amount during the loan’s term. You can withdraw money as you need it during that period. As you pay off the amount borrowed, you can use the available credit again.
Unlike a home equity loan, a home equity line of credit has a variable interest rate, meaning it can fluctuate during the loan’s term (although some lenders do offer a fixed-rate option). With a home equity line of credit, payments typically vary month to month depending on the interest rate, the amount owed, and whether the credit line is in the “draw period” or the “repayment period”.
The draw period refers to the period of time when you can borrow against the line of credit. During this period of time, your minimum monthly payments will cover only the interest, although you can choose to pay toward the principal, too. The repayment period begins after the draw period ends. During this period your monthly payments will include both interest and principal.
To learn more about BankFive’s home equity loans and HELOCs, go to: https://www.bankfive.com/home/personal-banking/home-equity-loans