If you're a homeowner who needs money to renovate, pay for repairs, or another purpose unrelated to your property, you may be in luck. If you have enough equity in your home, you can use it to secure a loan or a line of credit.
With a home equity loan or a home equity line of credit (HELOC), your home is used as collateral, giving lenders peace of mind. If you default on your payments after borrowing money, they have an easy means of getting repaid -- they can foreclose on your home and recoup what's owed to them.
As such, it's relatively easy to qualify for a home equity loan or a HELOC, provided that you have equity (you've paid down at least part of your mortgage). But, while both options are viable when you need to get your hands on cash, it often pays to opt for a HELOC over a home equity loan.
Home equity loans versus HELOCs
Home equity loans and HELOCs are both a means of borrowing against your home.
With a home equity loan, you borrow a specific amount of money and pay it back over time, just like any other type of loan. You’ll be put on a monthly payment schedule, and your payments will be a function of the amount you borrow coupled with the interest rate you secure (and it’ll probably be a favorable one, which is a benefit of home equity loans).
With a HELOC, on the other hand, you're not borrowing a lump sum and locking yourself into a repayment plan. Rather, you're securing a line of credit that you can draw on as the need arises. Say you're granted a $20,000 HELOC. If, six months later, you need $5,000, you can withdraw that sum, after which you’ll need to pay it back over time. You’ll then have access to the remaining $15,000 to borrow as needed. After you've paid back the $5,000, you can take out the full $20,000 if you need it.
Why choose a HELOC over a home equity loan?
The main benefit of a HELOC over a home equity loan is more flexibility. Rather than committing to borrowing a specific amount, you get the option to start small and borrow more over time.
Imagine that you're kicking off a major renovation and estimate that it will cost between $20,000 and $30,000. That's a wide range. If you take out a home equity loan for $30,000, you'll immediately start accruing interest on $30,000. But if you secure a $30,000 HELOC and only wind up needing $20,000 of it for that project, you won't be stuck paying interest on the remaining $10,000.
Of course, there are risks involved in both HELOCs and home equity loans. If you fail to repay either one, you'll risk losing your home to foreclosure. And both options make it easy to give in to temptation and borrow more money than you actually need, since qualifying for them is easy.
But because HELOCs don't lock you into borrowing a lump sum the way home equity loans do, they're often a better choice, particularly when you're not sure how much money you actually need to get your hands on.
Another thing to keep in mind is that while home equity loans generally impose closing costs, those same fees can be much lower with HELOCs. Some HELOCs don't charge closing costs at all.
Ultimately, both home equity loans and HELOCs are a reasonable option for borrowing money, especially since you'll typically snag a lower interest rate on them than what you'd get with a personal loan. And if you use either to improve your home, you can deduct the interest you pay on your home equity loan or HELOC on your taxes.
But if you're at all uncertain about how much money you need to borrow, it could be beneficial to set yourself up with a HELOC and enjoy the flexibility that comes with it.