There’s often confusion between home equity loans versus HELOCs (home equity lines of credit). Though both let you tap your home equity for cash, they function quite differently. HELOCs act as a line of credit, much like a credit card, while home equity loans offer a lump-sum payment all at once. Funds from both products can be used as the borrower sees fit.
What is home equity?
To understand home equity loans and HELOCs, you first have to understand home equity. Put simply, equity is the share of a home or property you actually own. To calculate how much equity you have, start with your home’s value and then subtract your remaining mortgage balance.
For example, if your home appraises for $280,000 and your current loan balance is $150,000, you have $130,000 in equity. As a percentage, you have a 46.42% equity stake.
Financial products like home equity loans and HELOCs allow you to borrow against this equity up to a certain point -- typically 80% to 85% for most lenders. You can use the funds to pay for home renovations, medical bills, tuition costs, or any other expenses you might have coming your way. You can also use home equity products to consolidate and pay off higher-interest debts like credit cards and personal loans.
Leveraging your home equity
Home equity products come with both pros and cons. On the plus side, home equity loans and HELOCs are fairly easy to come by since they’re secured by an asset. You’ll need decent credit, sure, but the main requirement with these loans is that you have equity in your home. The more you have, the better.
Another major benefit is that home equity loans and HELOCs offer much lower interest rates than other financial products. If your other options are personal loans or credit cards (which often have double-digit APRs), a home equity product can save you a lot of money.
Finally, interest on home equity loans and HELOCs is often tax-deductible as long as you use the funds to improve your property. This perk isn’t available on other financial products and can equal big savings over time.
There are downsides, though -- primarily, putting your home at risk. Since home equity products use your property as collateral, you could find yourself in danger of foreclosure if you fall behind on payments. If you opt for a home equity loan, this risk is even higher.
Home equity loans act as second mortgages, meaning you’ll need to make two mortgage payments each month to stay afloat. HELOCs often require smaller, interest-only payments for the first 10 years or so, making them easier to manage -- at least at the outset.
There are also costs to consider. Just like with your first mortgage loan, home equity products come with closing costs and fees. On HELOCs, you might even see fees each time you make a withdrawal. These can add up over time, especially if you expect to make several transactions over time.