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Unlike a HELOC, a home equity loan allows the borrower to take all the money upfront and makes principal and interest payments for a predetermined term. “If you need a large amount, a home equity loan may be the best way to go,” says Livingstone. Most of the payment pays down interest at first, then slowly pays off the principal over time. Ferlisi says lenders are also still a little gun-shy with HELOCs from the 2008 housing crash.
Ryan Eichler holds a B.S.B.A with a concentration in Finance from Boston University. He has held positions in, and has deep experience with, expense auditing, personal finance, real estate, as well as fact checking & editing. Amplify Credit Union provides fee-free banking and award-winning lending throughout Texas.
Cash-Out Refinance vs. Home Equity Loans
Cash out refinancing allows you to get extra cash by obtaining a new loan for a balance larger than the one on your existing mortgage. You can then use the cash for anything from home improvements to college tuition. In the end, you will have one new mortgage that covers both your primary home loan and the loan for the additional money.
At that point, you or your heirs can sell the home, pay off the reverse loan and keep any remaining proceeds from the sale. That advantage can make home equity loans attractive, but they come with financial responsibilities. Home equity isn’t based on your original home value but on what that property is worth today. According to the S&P CoreLogic Case-Shiller US National Home Price Index, the average home's value has more than doubled over the past ten years.
What type of loan do you need?
After the draw-down term ends, the repayment period begins, in which you’ll pay a combined interest-and-principal payment every month until the loan is paid off. This means you’re able to withdraw whatever you need from the loan, when you need it, up to the total approved limit. Each month, you only pay interest on the amount of the loan you’ve used, so you may not be paying interest on the full amount for which you qualify. However, HELOCs typically are adjustable-rate loans based on the prime rate, which means your interest rate could potentially rise over time. It functions like a credit card, but features a lower, variable interest rate. You can draw cash as you need it from a HELOC, and you only pay interest on the amount you borrow.
With a HELOC, you establish the line of credit upfront and access this money when you need it, only paying interest on what you borrow. You will generally also pay a fee to maintain the line of credit, but this is usually a fairly modest amount. When using home equity, it helps to understand loan options and the terms lenders offer you. When you have a mortgage and then add a home equity loan, you reduce your home equity. Any time you increase your total home loan balances, home equity declines.
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Home equity loans typically have favorable interest rates compared to unsecured personal loans. If you still owe money on your home, you’ll continue paying the same mortgage in addition to your home equity loan payments. Homeowners have several choices when it comes to tapping into the equity in their homes, including home equity loans and cash-out refinances. Compared to unsecured loans, both are relatively easy to qualify for and typically come with more favorable interest rates. While both loan options allow you to borrow against the equity in your home and access the cash immediately, the loan type and interest rates may make one a better choice over the other for you. If refinancing your mortgage would force you to get a significantly higher interest rate, it might make sense to look at alternatives like home equity loans.
The third major difference between HELOCs and second mortgages is that HELOCs offer variable interest rates. However, as is often the case in finance, there are pros and cons to this approach. By contrast, second mortgages follow a strict amortization schedule in which each payment includes both interest and principal.
Bank, says a home equity loan takes three to six weeks from application to funding. Lenders typically let you borrow up to about 80% of your equity with a home equity loan. This may influence which products we review and write about , but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research.
As with any credit product, HELOC lenders will perform a credit check as part of your application, resulting in a temporary dent in your credit score. However, as long as you make repayments on time, you can recover quickly. You’ll typically pay the loan back over a period of five years with interest, though some plans offer longer terms. Unlike other types of loans, however, you won’t pay interest to a bank, but rather pay it back into your own account. A 401 loan also isn’t a typical loan because you don’t have to pass a credit check to qualify.
The most common ways to use home equity are through a home equity loan, home equity line of credit , or a cash-out refinance mortgage. You won’t know what terms lenders will offer until you compare quotes from competing lenders. If you need a relatively low-cost form of financing, look into whether a home equity loan could offer attractive terms for your situation. Home equity loans may involve some fees upfront, plus ongoing interest on the amount you borrow.
She previously reported on retirement and investing for Money.com and was a staff writer at Time magazine. She has written for various publications, such as Fortune, InStyle and Travel + Leisure, and she also worked in social media and digital production at NBC Nightly News with Lester Holt and NY1. She graduated from the Craig Newmark Graduate School of Journalism at CUNY and Villanova University. When not checking Twitter, Alix likes to hike, play tennis and watch her neighbors' dogs.
Another advantage is that you can deduct mortgage interest payments from your taxes. Depending on your loan balance and rate, the deduction can reduce your taxable income significantly. Nicole Straub, the SVP and head of Discover Home Loans, advises homeowners with mortgages below the current market rates to consider the home equity loan rather than the other loan. Using home equity allows you to tap into your home equity while retaining the below-market rates of your primary mortgage. On the other hand, this type of loan is perfect if you want to keep your original mortgage. Retaining your terms might be good if you’re well into your amortization schedule.
Be prepared to have financial documents at the ready such as pay stubs and Form W-2s as well as proof of ownership and the appraised value of your home. Even as the housing market stagnates and a likely recession looms, Americans are sitting on trillions of dollars in home equity. Clever’s Concierge Team can help you compare local agents and negotiate better rates.
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