Home equity loans (HELs) or home equity lines of credit (HELOCs) allow you to get the money that you need through the equity in your home. Your bank will allow you to borrow a certain percentage of your equity. For example, if the bank allows a 75 percent HEL or HELOC and you have $40,000 equity in your home, you can borrow up to $30,000. Determine which type is best for you.
This interest rate can make a big difference in the total cost of your loan. HELs typically have a fixed interest rate, but may be variable. HELOCs are almost always variable rate loans. The interest rate on a variable loan is tied to the prime rate, which is set by the government. If interest rates go up, you may be in for a shock, as the cost of your loan rises dramatically.
When you apply for a HEL, you typically pay a closing fee to secure the loan, but this is less than what you paid as a closing fee for your original mortgage. You avoid this fee on a HELOC, but there may be an annual fee that you must pay.
Repaying the Loan
If you decide on a HEL, you will get a lump sum payment, which you then have to pay back in regular payments that include interest and principal. A HELOC works similar to a credit card--you have an upper limit and can take out as much or as little as you need, up to that limit, whenever you want. You must then make at least the minimum payment each month, but you can also pay off more.
Which Is Best
When you need to make one big lump sum payment, such as buying a new car or replacing your roof, a HEL is the smarter option. HELOCs work better in situations where you are not sure how much you will spend or the amount changes. For example, if you want to first renovate your kitchen and pay it off, then add an addition to your home, the HELOC may be a better choice.