Homeowner equity is near all-time highs right now as home prices have skyrocketed over the past few years. And while mortgage rates have been creeping up, they are still near low, historically speaking, making it a great time to tap that home equity for other financial needs. If you are considering using some of your equity through a second mortgage, you may be wondering whether to take out a home equity loan or a home equity line of credit (HELOC.) Here are the differences that may help you decide.

General Equity Loans Similarities

Both types of equity loans are second mortgages, as you already have a primary mortgage. They are both tied to your home as collateral. In the case that you default on your loans and your home goes into foreclosure, the first mortgage gets priority on the profits of the home sale, and whatever is left over after the first mortgage is repaid goes to the second mortgage. For this reason, second mortgages are riskier than primary home loans and the interest rates are slightly higher on home equity loans to reflect that possibility. However, both home equity loans and lines of credit usually have lower interest rates than those of credit cards and personal loans.

For any type of home equity loan, borrowers must have a substantial amount of existing equity in their properties. In general, most lenders like to see a minimum of 15% to 20%. The amount of money homeowners can pull out is calculated by subtracting the remaining mortgage balance from 85% of the home’s current value. For example, if your home is now worth $400,000, and you still owe $300,000 on your home loan, you could pull up to $40,000 out of your equity.

With both home equity loans and HELOCs you can use the money you obtain for any purpose; there are no restrictions on its use.

And for both types you’ll need to qualify for the loan. This typically requires a decent credit score, adequate income, and a lower debt-to-income ratio.

Now here’s how home equity loans and lines of credit differ:

Home Equity Loans

These work very much like a primary mortgage, as they usually have fixed rates and an amortized repayment schedule, making them very predictable. Once approved, you receive the equity as a lump sum to use for home renovations, debt consolidation, or any other financial need.

You will start making repayments on the home equity loan immediately and if you end up needing more funding you’ll have to first pay off the second mortgage before tapping more of your equity.

Home Equity Line of Credit (HELOC)

A HELOC works like a credit card tied to your home. Once approved, your lender sets a spending limit and a borrowing period.

This offers more flexibility than a home equity loan. You can borrow as little or as much as needed during a set period.

You only pay interest on what you use, not the full amount approved. Also, you don’t need to know the exact amount before applying. However, the interest rate is variable, making costs harder to predict.

Once the borrowing period ends, you must start full repayment and can’t withdraw more. During the draw period, you must make minimum monthly payments.

Both home equity loans and HELOCs offer low-interest funding. The best choice depends on your needs and comfort with a variable rate.

If you’re interested in a Home Equity Loan or a Home Equity Line of Credit, call us today!

These materials are not from HUD or FHA and were not approved by HUD or a government agency. We do not provide tax, legal or accounting advice