Now that you’re no kid anymore, you’ve got certain expenses to deal with. Luckily, if you own a home, you can tap into the equity to get through tough times, or you can use your equity to improve your home. Two ways of doing this are through a home equity loan, also called a second mortgage, or a home equity line of credit, also called a HELOC (pronounced "hee-lock"). These types of loans often are confused because they sound alike, but they are different, and depending on your circumstances, one may be a better choice than the other.
Home Equity Loan
A home equity loan works like a regular loan that you would get from your bank or credit union. You borrow a set amount of money that you must pay back according to the terms, which are usually 10 or 15 years. Generally, home equity loans have a fixed rate that you lock into. Your payments never change this way, and you have no surprises because you’ve secured the loan. These loans are also called second mortgages.
A HELOC allows you to have a revolving line of credit available for you to use as needed. You access this line either by writing a check or by using a credit card that your lender gives you. Just like a credit card, when you use your HELOC, you have a minimum monthly payment. You can choose to pay the minimum, or more than the minimum. HELOCs generally have a variable interest rate that is tied to the prime rate. The HELOC is typically one percent over prime.
Choosing a home equity loan over a HELOC depends on what you intend to use the money for and what type of person you are, according to CNNMoney.com. If you have a one-time project, such a specific remodel, or you want to pay off your credit card debt, a home equity loan works because you won’t need to keep tapping into a line, and you can be secure that your payments won’t go up if interest rates do. If you have ongoing expenses, such as a complete remodel of your home that uses different contractors, a HELOC is what you’ll need. You’ll be able to pay expenses as they arise.
Be careful about tapping into your equity in the first place. Home equity loans, or HELOCs, are not supposed to be for your vacations, spending sprees or to allow you to live above your means. Your home is on the line as soon as you take one out. If you can’t pay back the loan or line, you can lose your home. Before you take out a home equity loan or line of credit, decide how you are going to pay it back, recommends the Federal Reserve. Understand, for example, that if you choose an interest-only payment plan, you will be responsible for a balloon payment on the principal when the interest-only period ends.
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