If you own a home, paying your mortgage is a bit like paying into a long-term savings account. One day your mortgage will be paid off and the home will be yours, but what if there was a way access the money you’ve already invested in your home now? If you need money, your home’s equity—the difference between what you still owe and your home’s appraised market value—could be the answer.
There are two ways to borrow against your home’s equity: a home equity loan or a home equity line of credit (HELOC). Both act as second mortgages that allow you to use your equity for home improvements, medical care and other large expenses. But you shouldn’t dive into one or the other before doing your homework. Check out the ins and outs of tapping into your home equity.
What is a Home Equity Loan?
A home equity loan immediately advances you a sum of money that you pay back over a fixed time period at a fixed interest rate. Home equity loans are good for borrowers who like the certainty of fixed rates and fixed payments.
What is a Home Equity Line of Credit?
Unlike a home equity loan, which provides a lump sum all at once, a home equity line of credit acts like a credit card using your home as collateral. When you opt for a HELOC, you are approved for an established credit limit over a set time period. Then, once you have used the funds, you pay back the amount in monthly payments that will vary based on how much of the credit limit you are using. However, your interest rate will fluctuate as the market changes, also causing your payment amounts to vary. HELOCs are good if you want future flexibility to quickly access your equity.
Why Wouldn’t I Just Use a High-Limit Credit Card?
In most cases, tapping your home equity is a cheaper option. Since the collateral is your home, the lender assumes a much lower rate of risk. This means that you will likely have lower interest rates on your home equity loan or HELOC than you would on a credit card. Even better, many lenders offer introductory rates that are even cheaper—but beware, these introductory rates don’t last forever, so it is important to know what the regular rate might be.
What is the Financial Impact?
In general, there are very few or even no closing costs associated with taking out a home equity loan or HELOC if you have acceptable credit. While interest rates for HELOCs can change over time, all have a required cap by law on the amount of rate increase over the life of the loan.
Even better, because home equity loans and HELOCs are a type of mortgage, the interest you pay is tax deductible just like the interest on your mortgage. If you have questions about how to itemize your deductions to take advantage of the tax breaks, speak with your financial advisor.
Are There Any Drawbacks?
Quite simply, the biggest drawback to using your equity is that you are placing another lien on your home and if you don’t make your payments, you could put your home at risk. Consider whether you are borrowing money for something of lasting value, such as a home improvement or education expenses, versus transitory expenses such as vacations or cars. Because these loans offer lower interest rates than credit cards, using one to consolidate debt could be a good idea, but only if you don’t continue putting debt on the credit cards.
A home equity loan or line of credit could be a great option for you to access what you’ve already invested in your home to meet large expenses. To learn more about drawing on your home’s equity, visit https://www.thebalance.com/home-equity-loans-315556.
And if you’re instead in the market for a new home, visit http://www.nchfa.com/home-buyers to learn how we might help.